Economics assignment on: Market equillibrium

Using a graph, show how a tax affects initially unregulated market equilibrium for alcoholic drinks. Then, using welfare analysis, identify the differences in consumer surplus, producer surplus, deadweight loss and government revenue before and after the tax. [7 marks]

Mill (2008) is of the opinion that the concepts of demand and supply are two main constituents of the theory of consumer demand. Demand may be defined as a desire in the minds of the consumer to be backed by purchasing power. A demand without a purchasing power is a mere desire which may or may not get fulfilled in future. The amount of a particular commodity demanded by the consumer is called the quantity demanded. Since the consumer has to have the purchasing power to fulfill the demand there comes the role of price. The relationship of price and quantity demanded for a consumer is analyzed in the Law of Demand.

According to Jaffe (2009), the buyers will include the consumers, who buy goods and services, and the firms, who buy raw materials, labour and capital which they use in their production process. The sellers are those individuals who sell their goods or services. Thus, most people and most firms act both as buyers and sellers, but for simplicity we can consider them simply as buyers when they are buying some goods or services and as sellers when they are selling some goods or resources.

 Law of Demand and the demand schedule:

Provided other conditions remain constant, the quantity demanded of a particular commodity is inversely related to the price of the commodity. As the price of the commodity increases, the quantity demanded for the decreases and vice versa. In this case, we take the case of alcoholic drink and its price (Mill,2008).This relationship can be shown with the help of the following table:

This table depicting the different price levels of the drink and the respective quantity demanded for the drink is called a demand schedule. This, naturally, shows the price and quantity choice bundles of a single consumer. That is why this demand schedule is called an individual demand schedule. Aggregation of all individual demand schedules will give us the market demand schedule. From the market demand schedule we come to know the market price and the corresponding quantity offered against the price (Devereux, 2009).

The Individual and the market demand curve:

According to Page (2009), the graphical plotting of the individual demand schedule gives us what we call the demand curve. We plot the price in the vertical axis, as the independent variable, and the quantity demanded on the horizontal axis as the dependant variable. The locus of the points gives us the individual demand curve. If we plot the above schedule in the graph paper, the figure will be like this:Shift in the demand and supply curves: Effects of taxes:

A tax is a compulsory payment on the use of a particular good. The source of income for the governments of most of the countries is the taxes. Alcohol is an evil to general health. As a result, government imposes tax on alcohol. If taxes are imposed, the suppliers are compelled to increase the price of alcohol. The producers reduce their amount of production of alcohol, making the supply curve shift upward (leftward). The alcohol users exhibit an inelastic demand pattern, which means that the alcohol users will not stop using alcohol, even if the prices are higher.  The taxes make the prices of the alcohol higher, thereby reducing the amount received by the sellers and increasing the amount payable by the buyers. The buyers will not stop consuming alcohol; as a result, the supplier has to reduce production of alcohol.

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