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Show The case of monopolistic competition is much more difficult to analyze since the " industry" is comprised of many producers each faced with a highly elastic, yet downward sloping demand curve for their product. With free- entry and no externalities, the equilibrium position exists where the average revenue ( of the group- demand schedule) equals the average unit cost of the individual firm. Musgrave ( 1959) points out that if a unit tax is now imposed, we will witness a contracting of output and perhaps even a slight exodus from the industry. Eventually prices will rise enough to allow those left to recover part of the previous decline. Prices will rise but in the case of monopolistic competition with its limited production differentiation, price rises will fluctuate from firm to firm. A more complete analysis of many of the issues involved with monopolistic competition is discussed in the classic work of Due ( 1942). With oligopoly many alternative results are possible depending upon number of firms, shape of cost and revenue curves, and at what point on the curves equilibrium occurs. No attempt will be made to discuss the various alternatives here since they are discussed in some detail in Due ( 1942) and Sweezy ( 1939). However, one interesting phenomenon may occur under oligopoly which does not occur under any other market structure. This is illustrated in Figure F- 5. Unit tax and ad valorem tax compared Again using linear schedules it would be useful to compare the effect of a unit tax as compared to an ad valorem tax. How they are to be compared depends upon the purpose of the agent imposing the tax. If the purpose is to raise a certain amount of funds or restrict output to a given level we can compare them using Figure F- 6 in the case of a competitive market. units units Figure F- 5. Kinked demand. The demand curve is the kinked line AB and the corresponding marginal revenue is represented by the broken line BCDE. The line FG is the oligopolist's marginal cost schedule. A unit tax is now imposed and is represented by an upward shift of the cost schedule to LM. A downward shift of demand curve AB would yield the same result. In this case, however, price remains constant at P0, and there is no reduction of output. The entire tax is paid for out of the profit of the oligopolist. Figure F- 6. Perfect competition equal yield. Initial equilibrium without tax is at K. A unit tax is now levied if BH and new equilibrium is established at E with price Pi. Total tax yield is represented by DEFPj. For an ad valorem tax to provide equal yield, the new after- tax demand curve must pass through E and is represented by the line CA. In either case price, quantity, and yield are the same; however, as we look at the initial position we see that the initial burden was not the same. At the initial price P0, the unit tax equals MK but the ad valorem tax equals only LK. Since LK < MK the initial burden is greater under the unit tax and an ad valorem tax would be better. If it is necessary or desirable to formulate a tax with equal initial burden, the opposite question may be asked: What is the result when an ad valorem and a unit tax of equal initial burden are levied? As is illustrated in Figure F- 7, the ad valorem tax results in a higher price and a lower output. The total yield depends on the elasticities of demand and supply at the various quantities. If the goal of the controlling agency were to curtail consumption of the taxed product; however, the obvious choice would be the ad valorem tax. In Figure F- 8 we can compare the effect of an ad valorem and a unit tax which tax a monopoly in such a way as to generate the same final quantity and price. In equilibrium after the imposition of the tax, the price is Pi and the quantity if Qj. One important difference exists however, the total tax yield with the ad valorem 91 |
