4. The Laffer curve

Governments often place so-called sin taxes on goods or services such as cigarettes, alcohol, and pornography. These kinds of taxes are popular with politicians because they are usually more palatable to voters than income taxes.

To understand the effect of such a tax, consider the monthly market for adult DVDs, which is shown on the following graph.

Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph.

Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly.

Graph Input Tool Market for Adult DVDs 40 36 32 28 Quantity (DVDs) Demand Price (Dollars per DVD) Tax Wedge (Dollars per DVD) 80 24.00 8.00 Sup Supply Price (Dolars per DVD) 16.00 20 0 16 12 mand 0 20 40 60 80 100 120 140 160 180 200 QUANTITY (DVDs) Suppose the government imposes an $8-per-DVD tax on suppliers. At this tax amount, the equilibrium quantity of adult DVDs is DVDs, and the government collects $ in tax revenue. Now calculate the government's tax revenue if it sets a tax of $o, $8, $16, $20, $24, $32, or $40 per DVD. (Hint: To find the elbim quantity after the tax, adjust the "Quantity" field until the Tax Wedge equals the value of the per-unit tax.) Using the data you generate, plot a Laffer curve by using the green points (triangle symbol) to plot total tax revenue at each of those tax levels. Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically. 1600 T 1440 280 Laffer Curve 1120 960 800 640 02 480 320 160 0 4812 16 20 2428 32 36 40 TAX (Dollars per DVD) True or False: The government can raise its tax revenue by decreasing the per-unit tax on adult DVDs. True False Consider the deadweight loss generated in each of the following cases: no tax, a tax of $16 per DVD, and a tax of $32 per DVD. On the following graph, use the black curve (plus symbols) to illustrate the deadweight loss in these cases. (Hint: Remember that the area of a triangle is equal to Base Height. In the case of a deadweight loss triangle found on the graph input tool, the base is the amount of the tax and the height is the reduction in quantity caused by the tax.) 1600 1440 Deadweight Loss 1280 1120 960 800 640 480 320 160 increases at a constant rate 048 12 1620 24 2 TAX (Dollars per DVD) increases and then decreases increases by a greater and greater amount As the tax per DVD increases, deadweight loss