Tutorial Session (5)

Government Policies on the Demand and Supply

(Taxes and Subsidies)
Taxes and subsidies are example of the government intervention in the market.

First: Taxes
In this part, we want to know:

How does the tax affect the equilibrium price and quantity of good.
What is the distribution of the tax? (how much is paid by consumers and how much is
paid by producers?)

The consumer always pays the equilibrium price.

The producer always receives the equilibrium price minus the tax.
Consumer surplus and producer surplus before and after tax. And the dead weight loss. (page158
Mankiw textbook)

Example of tax:
The demand and supply function for a good are given as:
Demand function:
Supply function:

(1)
..(2)

a) Calculate the equilibrium price and quantity.

b) If the government imposes a tax of $6 per unit on seller.
i. Write down the equation of the supply function after tax.
ii. Find the new equilibrium price and quantity algebraically and graphically.
iii. Calculate the tax paid by consumer and producer.

Solutions
a) The equilibrium quantity is 90unites and the equilibrium price is $55 (find it on your
own)
b)
i.
The tax=$6 on seller , means the price received by sellers is
so the supply
function after tax is :

.(3)
..(4)

(After tax)

ii.

To find the new equilibrium price and quantity, solve equation (4) and (1)
simultaneously.

iii.

The Consumer always pays the new equilibrium price ($55+$3=$58)

This means the consumer pays 50% of the tax.
The producer receives the new equilibrium price minus the tax ($58-$6=$52)
This means that the producer pays 50% of the tax.

P=16+0.5Q
S2

100

S1

E2
Consumer price 58
55
Producer price 52

P=10+0.5Q
E1

16
P=100-0.5Q
10
84 90

Second: Subsidies:
1- A subsidy per unit sold shift the supply curve to the right, that the price
received by the producer is (P + subsidy)
2- The equilibrium price will decrease (the consumer pays the new lower
equilibrium price)
3- The price that the producer receives is (the new equilibrium price +the
subsidy).
4- The equilibrium quantity increases.
Example of Subsidies:
The demand and supply function are given as :
Demand function
Supply function
a) Calculate the equilibrium price and equilibrium quantity
b) The government provide a subsidy of $70 per unit sold
iv. Write down the equation of the supply function after subsidy
v. Find the new equilibrium price and quantity algebraically and
graphically.
vi. Calculate how much of subsidy received by consumer and producer.
Solutions:
a) The equilibrium quantity =50 unites / the equilibrium price =$350
b) Iv- with a subsidy of $70 per unit sold, the producer receives (
the new supply equation is

, so

So the supply curve will shift to the right by $70.

ii- to find the new equilibrium price and quantity , you have to solve the
original demand function and the new supply function simultaneously.
So, Q=60

P=330 (see the graph below)

P=100+5Q
S1

100

producer price 400

350

S2

E1

P=30+5Q
E2

consumer price 330

100

P=450-2Q
30
50 60

iii) The producer receives (the new equilibrium price +subsidy)

(330+70=400, which means an increase of $50 of the old equilibrium price.
The consumer pays the new equilibrium price which is $330. This means
that the consumer will receive 20/70 of the subsidy (28%).
Consumer, producer, and total surplus before and after tax
And the Deadweight loss

Consumer surplus
Producer surplus
Tax revenue
Total surplus
the area of C+E show the fall in the total surplus

before tax
A+B+C
D+E+F
None
A+B+C+D+E+F

after tax
A
F
B+D
A+B+D+F

change
(B+C)(D+E)(B+D)+
(C+E)-

Consumer and producer surplus

before and after the tax and
the Deadweight loss
Supply
after tax

Supply

A
Price buyers pay
B

Price without tax

D
Price sellers receive
F

demand

Q2

Q1