Suppose that a tax of $2 per unit of output is imposed on red rubber ball producers. What level of output maximizes profit?

Question

Quizplus · Accepted Answer

To find the level of output that maximizes profit, we need to examine the impact of the tax on producers' costs and revenues. The tax of $2 per unit increases the cost of producing each red rubber ball by $2, meaning the marginal cost curve shifts upward by $2. This results in a new marginal cost curve (MC') that is parallel to the original marginal cost curve (MC), but is $2 higher at every level of output.

To determine the new profit-maximizing level of output, we need to compare the new marginal cost curve (MC') with the marginal revenue curve (MR). The marginal revenue curve is the same as the demand curve since red rubber ball producers face perfectly elastic demand, meaning they can sell as many balls as they want at the market price of $6.

At the profit-maximizing level of output, marginal revenue equals marginal cost, so we need to find the point at which MC' intersects MR. From the graph, we can see that this occurs at an output level of 5. At this level of output, the price of a red rubber ball is $6, the marginal cost is $8, and the producers earn a profit of $6 - $8 = -$2 per ball.

Therefore, the answer is D, as an output level of 5 maximizes profit despite being negative, as this is still the level at which producers earn the highest profit possible after the tax is imposed.

Suppose That a Tax of $2 Per Unit of Output