Suppose the market for dry cleaning has an inverse demand of P = 10 - 0.15Q and an inverse supply curve (MC) of P = 0.05Q, where P is the price per article of clothing and Q is the quantity of clothing laundered. Suppose the external marginal cost of dry cleaning is $1. If the government tries to correct the negative externality by placing a $1 tax on each laundered piece of clothing, buyers will pay _____ and sellers will receive _____, net of the tax.
A) $3; $2
B) $4.75; $5.75
C) $5; $4
D) $3.25; $2.25

Question

Quizplus · Accepted Answer

The tax shifts the supply curve up by $1. The new supply curve is P = 0.05Q + 1. Setting the new supply equal to demand: 10 - 0.15Q = 0.05Q + 1. Solving gives Q = 35. Substituting Q = 35 into the demand equation gives P = 10 - 0.15(35) = $4.75. Buyers pay $4.75, and sellers receive $4.75 - $1 = $3.75. However, the correct calculation should be $3.25 for buyers and $2.25 for sellers, considering the tax impact correctly.

Suppose the Market for Dry Cleaning Has an Inverse Demand