Norm and Sheila consume only meat pies and beer. Meat pies used to cost $2 each and beer was $1 per can. Their gross income used to be $60 per week, but they had to pay an income tax of $10. Use red ink to sketch their old budget line for meat pies and beer.
(a) They used to buy 30 cans of beer per week and spent the rest of their income on meat pies. How many meat pies did they buy?
(b) The government decided to eliminate the income tax and to put a sales tax of $1 per can on beer, raising its price to $2 per can. Assuming that Norm and Sheila’s pre-tax income and the price of meat pies did not change, draw their new budget line in blue ink.
(c) The sales tax on beer induced Norm and Sheila to reduce their beer consumption to 20 cans per week. What happened to their consumption of meat pies? ______. How much revenue did this tax raise from Norm and Sheila? ______.
(d) This part of the problem will require some careful thinking. Suppose that instead of just taxing beer, the government decided to tax both beer and meat pies at the same percentage rate, and suppose that the price of beer and the price of meat pies each went up by the full amount of the tax. The new tax rate for both goods was set high enough to raise exactly the same amount of money from Norm and Sheila as the tax on beer used to raise. This new tax collects ______ for every bottle of beer sold and _____for every meat pie sold. How large an income tax would it take to raise the same revenue as the $1 tax on beer? _____. Now you can figure out how big a tax on each good is equivalent to an income tax of the amount you just found.
(e) Use black ink to draw the budget line for Norm and Sheila that corresponds to the tax in the last section. Are Norm and Sheila better off having just beer taxed or having both beer and meat pies taxed if both sets of taxes raise the same revenue?