A new payroll tax on businesses results in an increase in cost for each unit of production. Assuming no change in income or in the production mix, would this cause inflation?
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A. B. C. D. E.D
When firms face generally higher unit costs they decrease production. Assuming no change in income, there would be too many dollars (i.e. income) chasing too few goods (i.e. production). Although it may be tempting to say that costs are being "passed on" to consumers, this explanation is not economically viable. If demand for the product would support a higher price, then firms would have been charging a higher price prior to the oil shock and reaping higher profits. Even if we assume firms are "price takers," the new tax will take the firm's zero economic profit and turn it into an economic loss. The result will be fewer firms in the industry and less production overall.