Question

How does the imposition of a unit tax affect the supply curve of a firm?

Answer 1

A unit tax is the tax imposed on per unit of the output sold. Due to the imposition of unit tax, the cost of production per unit of output increases, which ultimately increases the marginal cost. Consequently, the LMC curve will shift leftward upward and as the supply curve is a portion of LMC, so the supply curve will also shift leftward upward.

Let us understand the effect of imposition of unit tax through an example.

Suppose that a firm is facing the price OP₁. LAC₁ and LMC₁ are the long run average cost curve and long run marginal cost curve respectively. Also assume that the government has imposed a unit tax of Rs k per unit of output produced. Now, this will rise the firm’s LAC and LMC, as the firm needs to pay Rs k extra on each output produced. Consequently, LMC₁ and LAC₁ will shift leftward upwards to LMC₂ and LAC₂. The magnitude of shift is equal to Rs k. As the supply curve is a part of LMC, it will also shift leftward from S₁ to S₂, due to the imposition of the tax. Consequently, the firm will now supply lesser units of output.