Question

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 vodka, 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 vodka 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 a $ 40-per-bottle tax on vodka.

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

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 _______ .

Answer 1

When govt. imposes a $20 tax

Blank 1 - equilibrium quantity - 56

Blank 2 - govt. collects - 20 x 56 = $1120

Table for laffer curve -

Tax	Qty	TR ( tax x qty )
0	70	0
20	56	1120
40	42	1680
50	35	1750
60	28	1680
80	14	1120
100	0	0

Laffer Curve graph -

The tax revenue can't be increased by imposing a tax $40 per bottle,

Hence the Statement is False.

D/W loss table-

Tax	Qty	D/W loss
0	70	0
40	42	560 ( 0.5 x 40 x ( 70 - 42 ) )
80	14	2240 ( 0.5 x 80 x ( 70 - 14 ))

Graph -

From the table, we can see that when the tax increases, the deadweight loss increases increasingly. (blank)