Multiple choice

The imposition of ad valorem tax on monopoly leads to

  1. p rises, q rises

  2. p rises, q falls

  3. p falls, q rises

  4. p falls, q falls

Reveal answer Fill a bubble to check yourself
B Correct answer
Explanation

An ad valorem tax (percentage-based tax) increases the monopolist's marginal cost at every output level. To maximize profit, the monopolist reduces output and raises the price. Both price increase and quantity reduction are proportional to the tax rate. This tax burden is shared between the monopolist and consumers depending on price elasticity.

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