You are hired as an economic consultant by the Federal Treasury to analyse the impact of a fee or a tax in a market, taking account of different potential market structures. In your answer you should use appropriate models (and diagrams) studied in class. Consider the financial services market. Assume for now that the market is competitive with many buyers and sellers, that financial services are a homogeneous good and that market demand and short-run market supply are linear and respectively downward and upward-sloping. At the current market equilibrium supply is more inelastic than demand. Assume also that the financial services industry is a constant-cost industry in the long run. To fund extra regulatory functions, the Federal government introduces a per-unit tax (called a financial services government fee) for every unit of financial services traded in the market.
- What is the impact of the new financial services government fee in this industry in the short run? What is the economic incidence of the fee? In other words, analyse and explain who bears the burden of the new fee. (4 marks)
- The Treasury is interested in the impact of the fee in the financial services market in the long run. Analyse the impact and economic incidence of this fee in the long run in this competitive industry. Compare your answer to the short-run case discussed in part (a). (3 marks)
- Now assume that the financial services industry is instead a monopoly, serviced by just one firm. The monopolist faces the same market demand curve for financial services as in parts a-b, and incurs marginal costs as in the competitive market above (but without new firms entering/exiting the industry). Analyse the impact of the fee levied on the monopoly market outcome and the economic incidence of the fee in the long run. (4 marks)
- Thinking more broadly, if as an economic consultant you observe a price rise in a market in the long run that is smaller than the per-unit tax levied, what can you imply about the structure of that market? Explain briefly. (2 marks)
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