Imagine a city where tram and bus trips are both provided by private companies, and, from a consumer perspective, these services are viewed as substitutes. The demand for tram trips is:
D1 = 315 - 75P1 + 5P2 + 0.002Y (1)
Where D1 is monthly demand for tram trips (in thousands), P1 is price of tram trips, P2 is price of bus trips and Y is average annual income. Assume the supply of tram trips by the industry can be described by:
S1 = 25P1 (2)
Where S1 is the number of tram trips per month (in thousands), and the market clears so:
D1 = S1 (3)
Assume the average annual income, Y, is $80,000 and the price of bus trips is P2 = $5. Further, assume the market always clears, there are no empty tram and buses, and producers are competitive. Ignore externalities such as pollution.
Answer the following questions:
Section B (25 Marks)
Assume the government puts a $1 tax on each tram trip, which is levied on tram companies. Answer the following questions:
1. What is the new price of tram trips to consumers? (5 Marks)
2. What is the new price of tram trips to tram companies? (5 Marks)
3. How many tram trips are now supplied and bought? (5 Marks)
4. Present the relevant diagram. (5 Marks)
5. How much tax revenue is raised? (5 Marks)