Part I: Excise Tax

1. Consider the ice cream market in Madison. In July, the ice

cream market demand and supply curves are given by the
following equations where Q is the quantity to ice cream units
and P is the price in dollars per unit of ice cream:
Demand: Q = 14000 10P
Supply: Q = 2000 + 20P
a)Find the equilibrium price and quantity of ice cream in July.

In equilibrium, we know that the quantity demanded = quantity

supplied. Thus, by solving the two equations, we have the
equilibrium price = $400 per unit of ice cream and the
equilibrium quantity = 10,000 units of ice cream.

b) Calculate the price elasticity of demand and supply at the

equilibrium price in July. Use the point elasticity formula to
compute these two values of these elasticities.

Answer:
The point elasticity of demand formula is
Elasticity of Demand = (-1/slope)(P/Qd)
and the point elasticity of supply formula is
Elasticity of Supply = (1/slope)(P/Qs)
At the equilibrium quantity and price we know (Q, P) = (10000,
400). We also have the demand and supply equations, but they
are not in slope-intercept form. So, rewriting the two equations
in slope-intercept form we have:
Demand Equation: P = 1400 (1/10)Qd
Supply Equation: P = (1/20)Qd 100
Now, we are ready to use the point elasticity formulas:
Point Elasticity of Demand = [-1/(-1/10)][400/10000] = .4
(hence, demand is inelastic at the point of equilibrium in this
market)
Point Elasticity of Supply = [1/(1/20)][400/10000] = .8

In October, ice cream demand in Madison decreases. So, the

new demand curve is given by
Demand: Q = 7000 30P
Assume the supply curve doesnt change.

c) Find the equilibrium price and equilibrium quantity in

October, and calculate the price elasticity of demand and supply
at this new equilibrium price. Use the point elasticity formula in
calculating these values.

Answer:
By solving the two equations, we obtain the equilibrium price
of$100 per unit of ice cream and quantity of 4,000 units.

To find the price elasticity of demand using the point elasticity

formula:
Price elasticity of demand = [(-1)/(-1/30)][100/4000] =
(30)(1/40) = .75

To find the price elasticity of supply using the point elasticity

formula:
Price elasticity of supply = [(1)/(1/20)][100/4000] = (20)(1/40) =
.5

Lets return to the July. Suppose that the city of Madison

imposes on producers an excise tax of $15 per unit of ice cream.

d) For part (d), answer this set of questions based upon this new
tax and the demand and supply curves you have been given in
this problem.
1. How does this excise tax affect the supply curve for ice
cream producers in Madison? Explain your answers in
words as well as in an equation.
2. Then, calculate the new equilibrium price and quantity in
July for this ice cream market.
3. Then, calculate the new equilibrium price and quantity in
October for this ice cream market.

Answers:
1. The imposition of the excise tax on producers effectively
increases the costs of production for the ice cream
producers since they now must also include paying the
government an excise tax of $15 per unit of ice cream they
produce. We can model this in two different ways: as done
in class, this excise tax will shift the supply curve up so that
the new y-intercept of the supply curve with the tax will
now be the old y-intercept plus 15 (this plus 15 reflects
the idea that the producers now have a new cost that they
must cover). Thus, if the supply curve was Q = 2000 + 20P,
then we could rewrite the supply curve in slope intercept
form as P = (1/20)Q 100. Therefore the new supply curve
that includes the tax would be P = (1/20)Q 85.
 Alternatively, you could take the existent supply curve in
July written in x intercept form and view the tax as
effectively decreasing the amount per unit that the producer
receives by 15. Thus, instead of P in this original supply
curve, the tax results in the new price with the tax being P
15. If, we plug that into the original supply curve
equation this is what we get:
Q = 2000 + 20(P 15)
Q = 2000 + 20P 300
Q = 1700 + 20P, the new supply curve in JULY written in
x intercept form.
Lets check that this new supply equation is the same as we
found in the first method: that is, is P = (1/20)Q 85 the
same as Q = 1700 + 20P?
20P = Q 1700
P = (1/20)Q 1700/20
P = (1/20)Q 85
Yes, these two approaches give us the same new supply
equation with the excise tax.

2. In July the relevant demand equation is Q = 14000 10P

and the relevant supply equation is Q = 1700 + 20P (see
explanation in the answer to #1 of part (d)). Solving for
equilibrium with these two equations we get:
14000 10P = 1700 + 20P
30P = 12300
P in July = $410 per unit of ice cream
Q = 1700 + 20(410)
Q in July = 9900 units

3. In October the relevant demand equation is Q = 7000 30P

 and the relevant supply equation is Q = 1700 + 20P (see
explanation in the answer to #1 of part (d)). Solving for
equilibrium with these two equations we get:
7000 30P = 1700 + 20P
50P = 5300
P in October = $106 per unit of ice cream
Q = 7000 30(106)
Q in October = 3820 units

e) Calculate the consumers tax burden ratio in July and in

October given your answers in (d) and then analyze the answers
you get for these two calculations by filling out the table
provided and then writing a verbal explanation of the difference
you find with regard to the two consumers tax burden ratios.
Your explanation should include the impact of demand and
supply elasticities on these calculations. The tax burden ratio can
be found by using the following equation:

Consumers tax burden ratio = (consumers tax

incidence)/(total tax revenue)

Here is a table that will help you organize your data:

July October
No Tax Tax No Tax Tax
Price
Quantity
Price --- ---
Elasticity
of
Demand
Price --- ---
Elasticity
of
Supply

Answers:
Total tax revenue in July is (tax per unit)(number of units sold
with the tax) = ($15 per unit)(9900 units) , and consumers tax
incidence is (equilibrium price with the excise tax the old
equilibrium price)(number of units sold with the tax) = ($410
per unit$400 per unit)(9900) = ($10 per unit)(9900 units).
Thus, consumers tax burden ratio in July is 2/3 (that is,
consumers end up paying 67% of the excise tax on ice cream in
July.

Tax revenue in October is ($15 per unit)(3820 units), and

consumers tax incidence is (equilibrium price with the excise
tax the old equilibrium price)(number of units sold with the
tax) = ($106 per unit - $100 per unit)(3820 units) = ($6 per
unit)(3820 units). Thus, consumers tax burden ratio in October
is 2/5 (that is, consumers end up paying 40% of the excise tax on
ice cream in October).