Raymond Hayden Economics

The Market For Pizza Is Characterized By A Downward

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Questions for Review

1. What happens to consumer and producer surplus when 3. the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax 4 revenue? Explain.

2. Draw a supply-and-demand diagram with a tax on the 5 sale of the good. Show the deadweight loss. Show the tax revenue.

How do the elasticities of supply and demand affect the deadweight loss of a tax? Why do they have this effect?

Why do experts disagree about whether labor taxes have small or large deadweight losses?

What happens to the deadweight loss and tax revenue when a tax is increased?

Problems and Applications

1. The market for pizza is characterized by a downward-

sloping demand curve and an upward-sloping supply curve.

a. Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and producer surplus. Is there any deadweight loss? Explain.

b. Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold. Illustrate the effect of this tax on the pizza market, being sure to label the consumer surplus, producer surplus, government revenue, and deadweight loss. How does each area compare to the pre-tax case?

c. If the tax were removed, pizza eaters and sellers would be better off, but the government would lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their gains to the government. Could all parties (including the government) be better off than they were with a tax? Explain using the labeled areas in your graph.

2. Evaluate the following two statements. Do you agree?

Why or why not?

a. "If the government taxes land, wealthy landowners will pass the tax on to their poorer renters."

b. "If the government taxes apartment buildings, wealthy landlords will pass the tax on to their poorer renters."

3. Evaluate the following two statements. Do you agree?

Why or why not?

a. "A tax that has no deadweight loss cannot raise any revenue for the government."

b. "A tax that raises no revenue for the government cannot have any deadweight loss."

4. Consider the market for rubber bands.

a. If this market has very elastic supply and very inelastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Use the tools of consumer surplus and producer surplus in your answer.

b. If this market has very inelastic supply and very elastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Contrast your answer with your answer to part (a).

5. Suppose that the government imposes a tax on heating oil.

a. Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain.

b. Would the revenue collected from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain.

6. After economics class one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. In what sense is taxing food a "good" way to raise revenue? In what sense is it not a "good" way to raise revenue?

7. Senator Daniel Patrick Moynihan once introduced a bill that would levy a 10,000 percent tax on certain hollow-tipped bullets.

a. Do you expect that this tax would raise much revenue? Why or why not?

b. Even if the tax would raise no revenue, what might be Senator Moynihan's reason for proposing it?

8. The government places a tax on the purchase of socks.

a. Illustrate the effect of this tax on equilibrium price and quantity in the sock market. Identify the following areas both before and after the imposition of the tax: total spending by consumers, total revenue for producers, and government tax revenue.

b. Does the price received by producers rise or fall? Can you tell whether total receipts for producers rise or fall? Explain.

c. Does the price paid by consumers rise or fall? Can you tell whether total spending by consumers rises or falls? Explain carefully. (Hint: Think about elasticity.) If total consumer spending falls, does consumer surplus rise? Explain.

9. Suppose the government currently raises $100 million through a $0.01 tax on widgets, and another $100 million through a $0.10 tax on gadgets. If the government doubled the tax rate on widgets and eliminated the tax on gadgets, would it raise more money than today, less money, or the same amount of money? Explain.

10. Most states tax the purchase of new cars. Suppose that New Jersey currently requires car dealers to pay the state $100 for each car sold, and plans to increase the tax to $150 per car next year.

a. Illustrate the effect of this tax increase on the quantity of cars sold in New Jersey, the price paid by consumers, and the price received by producers.

b. Create a table that shows the levels of consumer surplus, producer surplus, government revenue, and total surplus both before and after the tax increase.

c. What is the change in government revenue? Is it positive or negative?

d. What is the change in deadweight loss? Is it positive or negative?

e. Give one reason why the demand for cars in New Jersey might be fairly elastic. Does this make the additional tax more or less likely to increase government revenue? How might states try to reduce the elasticity of demand?

11. Several years ago the British government imposed a "poll tax" that required each person to pay a flat amount to the government independent of his or her income or wealth. What is the effect of such a tax on economic efficiency? What is the effect on economic equity? Do you think this was a popular tax?

12. This chapter analyzed the welfare effects of a tax on a good. Consider now the opposite policy. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain.

13. (This problem uses some high school algebra and is challenging.) Suppose that a market is described by the following supply and demand equations:

a. Solve for the equilibrium price and the equilibrium quantity.

b. Suppose that a tax of T is placed on buyers, so the new demand equation is

Solve for the new equilibrium. What happens to the price received by sellers, the price paid by buyers, and the quantity sold?

c. Tax revenue is T X Q. Use your answer to part (b) to solve for tax revenue as a function of T. Graph this relationship for T between 0 and 300.

d. The deadweight loss of a tax is the area of the triangle between the supply and demand curves. Recalling that the area of a triangle is 1/2 X base X height, solve for deadweight loss as a function of T. Graph this relationship for T between 0 and 300. (Hint: Looking sideways, the base of the deadweight loss triangle is T, and the height is the difference between the quantity sold with the tax and the quantity sold without the tax.)

e. The government now levies a tax on this good of $200 per unit. Is this a good policy? Why or why not? Can you propose a better policy?

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