Sub: Economics

Topic: Micro Economics

Question: Determination of equilibrium price and quantity demanded given demand and supply curve and maximization of the
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tax revenue
Suppose the Demand and Supply curves for coffee bean is given by

QD = 10 P

QS = P

Where Q denotes the tons of coffee bean and P denotes the price per ton. A) Whats the equilibrium price and quantity? b) Suppose that government want to tax coffee bean by $t per ton. What values of t maximizes governments tax revenue? Solution:
(a) Demand Supply QD = 10 P QS = P

With the help of above demand and supply equations we can find the value of equilibrium Price and Quantity by equating them.
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Sub: Economics

Topic: Micro Economics

10 P = P 2P = 10 P=5 Therefore, Quantity would be QD = 10 P QD = 10 5 QD = 5 tons (b) Suppose the government wants to tax coffee bean by $t per ton. The given demand and supply function are Demand Supply P = 10 QD P =QS Now, the government is imposing the tax by $t amount The supply curve will shift by the exact tax amount of t The new supply curve will be, P= Qs + t QD = 10 P QS = P

Inverse demand and supply function are

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Sub: Economics

Topic: Micro Economics

The new demand and the new supply curve we get, QD= 10-P P= 10-Q The supply equation, P= Qs+t Equating demand and supply equation we get, 10-Q= Q+t 10-t= 2Q Q= 10-t/2 = 5-t/2 This is the new equilibrium quantity The government revenue is nothing but the area of the shaded rectangle shown in the above figure.
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Sub: Economics

Topic: Micro Economics

The area= t * ( 5-t/2)= 5t- t2/2 The government revenue will be maximized if the first derivative of the function will be zero Setting the first derivative of the function is equal to zero we get, 5- 2t/2=0 5-t=0 t=5 The new equilibrium quantity will be, Q= 10-t/2 = 5-t/2 Q= 5- 5/2=5-2.5=2.5 Plugging the values in the demand equation we get, QD= 10-P 2.5= 10-P P= 7.5 Thus after the tax the new equilibrium price is 7.5 and the new equilibrium quantity is 2.5 The consumers are paying 7.5-5= 2.5 and the rest ( 5-2.5)= 2.5 are paid by the producers. Government revenue= 2.5*5= 12.5 That is the maximum revenue that government can earn by imposing the tax $5 per ton.

** End of the Solution **

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*The Homework solutions from ClassOf1 are intended to help the student understand the approach to solving the problem and not for
submitting the same in lieu of your academic submissions for grades.