Question 3

3. Relationship between tax revenues, deadweight loss, and demand elasticity The government is considering levying a tax of $30 per unit on suppliers of either windbreakers or bucket hats. The supply curve for each of these two goods is identical, as you can see on each of the following graphs. The demand for windbreakers is shown by Dw (on the first graph), and the demand for bucket hats is shown by DB (on the second graph). Suppose the government taxes windbreakers. The following graph shows the annual supply and demand for this good. It also shows the supply curve (S + Tax) shifted up by the amount of the proposed tax ($30 per windbreaker). On the following graph, use the green rectangle (triangle symbols) to shade the area that represents tax revenue for windbreakers. Then use the black triangle (plus symbols) to shade the area that represents the deadweight loss associated with the tax. Windbreakers Market S+ Tax Supply Tax Revenue Deadweight Loss PRICE (Dollars per windbreaker) DW D 100 150 200 250 300 350 400 450 500 550 800 QUANTITY (Windbreakers) Instead, suppose the government taxes bucket hats. The following graph shows the annual supply and demand for this good, as well as the supplyOn the following graph, do for bucket hats the same thing you did previously on the graph for windbreakers. Use the green rectangle (triangle symbols) to shade the area that represents tax revenue for bucket hats. Then, use the black triangle (plus symbols) to shade the area that represents the deadweight loss associated with the tax. @ Bucket Hats Market 860 - 55 Supply 0 Tax Revenus B Deadweight Loss 45 40 35 an 25 PRICE {Daollars perhat) 20 D &0 100 150 200 250 300 350 400 450 500 550 G600 QUANTITY (Hats) Complete the following table with the tax revenue collected and deadweight loss caused by esch of the tax proposals. Tax Revenue Deadweight Loss If the Government Taxes... (Dollars) (Dollars) Windbreakers at 30 per windbreaker I:l Bucket hats at 530 per hat I:l Suppose the government wants to tax the good that will generate more tax revenue at & lower welfare cost. In this case, it should tax W because, all else held constant, taxing a good with a relatively W elastic demand generates larger tax revenue and smaller deadweight loss. Consider the deadweight loss generated in each of the following cases: no tax, a tax of $20 per pack, and a tax of 340 per pack. On the following graph, use the black curve (plus symbols) to illustrate the deadweight loss in these cases. (Hint: Remember that the area of 3 triangle is equal to % % Base x 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.) 500 430 400 350 300 230 200 150 DEADMWEIGHT LOSS (Dollars) 100 50 0 0 5 10 15 20 25 30 35 40 TAX (Dollars per pack) As the tax per pack increases, deadweight loss 45 -ttt 50 %/ Deadweight Loss e e 4. The Laffer curve Government-imposed taxes cause reductions in the activity that is being taxed, which has important implications for revenue collections. To understand the effect of such a tax, consider the monthly market for cigarettes, 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. MNote: 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 Cigarettes 50 / 45 ' I Quantity 40 (Packs) Demand Price Supply Price = {(Dollars per pack) 30.00 {Dollars per pack) 20.00 Tax - (Dollars per pack) 10.00 25 20 PRICE (Daollars per pack) 0 5 10 15 20 25 30 35 40 45 50 QUANTITY (Packs) Suppose the government imposes a $10-per-pack tax on suppliers. At this tax amount, the equilibrium quantity of cigarettes is \\:l packs, and the government collects in tax revenue. Now calculate the government's tax revenue if it sets 3 tax of 30, $10, 520, $25, $30, $40, or $50 per pack. (Hint: To find the equilibrium guantity after the tax, adjust the "Quantity\" field until the Tax 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 leveis. Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically. @ 400 A 360 10 Laffer Curve 280 240 200 160 [AX REVENUE (Dollars) 120 a0 40 0 3 10 15 20 25 30 35 40 45 30 TAX (Dollars per pack) Suppose the government is currently imposing a $10-per-pack tax on cigarettes. True or False: The government can raise its tax revenue by decreasing the per-unit tax on cigarettes. O True O False