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1. Tax incidence in the long- and short-run
Consider a perfectly competitive constant-cost industry in long-run equilibrium, which produces toothbrushes that currently sell at an equilibrium price of $2.00 each.
a. The government introduces a tax of $0.50per toothbrush; the proceeds are to be used for “dental education.” Explain, with the aid of appropriate diagrams (for both a typical firm, and the industry) why, in the short-run, the price paid by consumers for toothbrushes will rise by less than $0.50, but in the long-run the prices will rise by $0.50.
b. Suppose that the tax were levied at a percentage rate (rather than a fixed “specific” rate per toothbrush) of 25%. How would the diagrammatic analysis differ from that of 5.a.?
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