Order Description
In 750 words
Background to the question
There has been a recent proposal to levy a fee (or a tax) on financial services to help fund the
industry regulator, ASIC (Australian Securities and Investments Commission). There are other
examples of a tax levied on firms to help pay for various government services (such as the paid
parental leave scheme several years ago).
QUESTION
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.
a. 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)
b. 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)
c. 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)
d. 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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