A sales tax of 10 % is placed on half of the firms (the polluters) in a competitive industry. The revenue is paid to the remaining firms (the non polluters) as a 10 percent subsidy on the value of output sold. Supposing that all firms have identical constant long-run average costs before the sales tax-subsidy policy, what do you suppose to happen to the price of the product, the output of each of the firms, and industry output, in the short run and the long run?
The price of the product based on the quantity generated by all firms in the industry. The immediate response to the sales-tax=subsidy policy is reduction in quantity through polluters and a raise in quantity by non-polluters. If long-run competitive equilibrium existed before the sales-tax=subsidy policy, price would have been equivalent to marginal cost and long-run minimum average cost. For the polluters, the price after the sales tax is below long-run average cost; thus, in the long run, they will exit the industry. In addition, after the subsidy, the non-polluters earn economic profits that will encourage the entry of non-polluters. If it is a constant cost industry and the loss of the polluters' output is compensated by raise in the non-polluters' output, the price will remain constant.