Question

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 rum, 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.

Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly.

Suppose the government imposes a $ 20-per-bottle tax on suppliers.

At this tax amount, the equilibrium quantity of rum is _______ bottles, and the government collects $_______  in tax revenue.

Now calculate the government's tax revenue if it sets a tax of $ 0, $ 20, $ 40, $ 50, $ 60, $ 80, or $ 100 per bottle. (Hint: To find the equilibrium quantity 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 levels.

Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically.

 

Suppose the government is currently imposing an $ 80-per-bottle tax on rum.

True or False: The government can raise its tax revenue by decreasing the per-unit tax on rum.

True

False

Consider the deadweight loss generated in each of the following cases: no tax, a tax of $ 40 per bottle, and a tax of $ 80 per bottle.

On the following graph, use the black curve (plus symbols) to illustrate the deadweight loss in these cases. (Hint: Remember that the area of a triangle is equal to 1/2 × Base × 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.)

As the tax per bottle increases, deadweight loss _______ 

• increases at a constant rate

• increases by a greater and greater amount

• increases and then decreases

 

 

Answer 1

When the tax is $20 the equilibrium is 40 and the government collect $800 as tax revenue.

The given data is executed in an excel and the Tax revenue is calculated:

The required Laffer curve is drawn from the above table:

If the government is currently imposing a tax of $20 per bottle.

Then if the government want to increase its tax revenue it can be increased by increasing the per bottle tax. That can be observed from the Laffer curve.

So, True.

The deadweight loss is calculated at tax 0, $40 and $80.

From the graph we can observe that when the tax per bottle increases then the deadweight loss increases by a greater and greater extent.