a. Consider first an ad valorem tax on the price of a monopoly’s good. This tax reduces the net price received by the monopoly from P to P (1 −t) −where t is the proportional tax rate. Show that, with a linear demand curve and constant marginal cost, the imposition of such a tax causes price to increase by less than the full extent of the tax.
b. Suppose that the demand curve in part (a) were a constant elasticity curve. Show that the price would now increase by precisely the full extent of the tax. Explain the difference between these two cases.
c. Describe a case where the imposition of an ad valorem tax on a monopoly would cause the price to increase by more than the tax.
d. A specific tax is a fixed amount per unit of output. If the tax rate is τ per unit, total tax collections are τQ. Show that the imposition of a specific tax on a monopoly will reduce output more (and increase price more) than will the imposition of an ad valorem tax that collects the same tax revenue.