Question 3:

Part III. 15. 16. 17. 18. Incidence This problem invites you to think work through an example of the incidence of a tax and the possibility of compensating for lost surplus through revenue reallocation. Consider a market for a good X with the following equations. Total benet is 100X 0.5X2. Total cost is 2X2. The good has a total externality equal to 5X + 0.125X2. What is the consumer surplus, producer surplus and total external damages in this market when there is no tax? (3 points) Suppose that a corrective tax following the Pigouvian prescription is employed. What is that tax rate? (1 point) What is the new consumer surplus, producer surplus, total externality and govern- ment revenue? Before you calculate your answers, inspect the supply and demand curves and try to predict which side of the market do you expect to bear a larger share of the burden of the tax. Then check your reasoning after you nd the an swers. (4 points) Suppose that the damages from the externality were felt by the consumers in this market. How much revenue would need to be given to consumers to make them as well off as before the tax. How much revenue would need to be given to producers in order to make them just as well off as before the tax? (2 points)