Question #1

In an effort to reduce alcohol consumption, the government is considering a $1 tax on each gallon of liquor sold (the tax is levied on the producers). Suppose that the supply curve for liquor is upward sloping and its equation is Q=30,000P (where Q is the number of gallons of liquor and P is the price per gallon). The demand curve for liquor is Q=500,000 - 20,000P.

• Draw a sketch to illustrate the excess burden of the tax and calculate.
• Suppose that each gallon of liquor consumed generates a negative external cost of $0.50. How does this affect the excess burden associated with the unit tax on liquor?

Question #2

State and explain the Ramsey and inverse elasticity rules for efficient commodity taxation.

Question #3

Commodity taxes are most likely to be a useful part of an optimal tax system if there are major consumption goods that are price (a) inelastic and income elastic. (b) elastic and income elastic. (c) inelastic and income inelastic. (d) elastic and income inelastic.