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IAI Actuarial Core Principles · Business Economics · Relationship between the government and the individual firm

A government imposes a fixed per-unit excise duty on a product sold by firms in a competitive market. Which statement correctly describes the effect on the firm's cost curves?

A per-unit excise duty raises marginal cost and average variable cost by the amount of the duty at every output level, because it is paid on each unit sold. It does not change fixed costs, which do not vary with output.

  1. AMarginal cost and average variable cost both shift upward by the amount of the duty, while fixed cost is unchangedCorrect
  2. BOnly fixed cost rises, so marginal cost is unchanged
  3. CMarginal cost falls because output falls
  4. DAverage fixed cost rises by the amount of the duty
  5. Only average fixed cost and total fixed cost are affected

Explanation

A per-unit tax rises with output, so it behaves like a variable cost. Marginal cost and average variable cost shift up by the tax per unit. Fixed cost is unaffected by output, so options treating the duty as a fixed cost are wrong.

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