Part 1

Greg Mankiw is basically a Buddhist monk who has trained his mind to no longer desire more material comforts from consumption. The only thing Greg wants is to depress economic mobility by making sure his descendants retain their position at the very top of the economic ladder. Greg is able to invest his money in an account that pays 10% annual interest. He can make this investment year after year.

a. Assume Greg starts with $1,000,000, how much money could he leave his children as an inheritance next year if there are no taxes?

Now suppose Greg's interest earnings are taxed at 20% each year. We can define his effective tax rate as

ETR= 1 - What greg could leave his children with the interest earning tax / what greg could have leave his children without the interest earning tax

b. With the 20% interest earnings tax, what is his ETR for the first year?

c. Repeat the calculations above to find Greg's ETR after 10 years and after 25 years. How does it vary over time?

Part 2

Back to Philadelphia. You are hired by the Philadelphia city government to consult on their soda tax. Your undergraduate research assistant estimated these supply and demand equations for soda in Philadelphia:

QD = 350 - 50 P

QS = -400 +200P

The original $2 tax/unit has not generated as much revenue as hoped and people in the city government are arguing about how to generate more tax revenue.

They turn to you and ask you to find the tax that maximizes revenue generated. What is it? Show your work and explain it.