Now assume that a 20% VAT is imposed. When a new market equilibrium is reached, the market values of the various goods will have changed in a manner that cannot be precisely predicted; for simplicity, therefore, let us consider merely how the tax affects the three firms at the prices given. The tax is payable at the time of sale, and the tax for each firm is calculated by subtracting the costs of the factors purchased from the final sale price.

For instance, Firm A's tax on its $20 profit is $20 20% = $4.00. Notice, however, that A must pay its tax one year earlier than the other two firms. In order to account properly for this difference in time preference when comparing the firms, we shall consider their tax relative to the same reference point in time—specifically, at Year 2. At the prevailing 10% interest rate, Firm A's $4.00 tax at Year 1 equates to a $4.40 tax at Year 2. The taxes of the three firms are compared in the table on the next page.

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