Question

2 Taxes: Suppose liquor stores are required to pay a $5 tax on each case of beer sold.

a. Illustrate this policy, make sure to indicate consumer surplus, producer surplus, government revenue and deadweight loss.

b. In a separate diagram, illustrate the tax burden on consumers and the tax burden on producers due to this policy.

c. Suppose the supply of beer is relatively elastic while the demand is relatively inelastic, which side of the market will bear the larger tax incidence (i.e. pay a larger portion of the tax)?

Answer 1

a) A tax on suppliers will shift the supply curve up. This reduces the price received by sellers from P0 to P2 and increases the price paid by buyers from P0 to P1. Quantity is reduced from Q0 to Q1. Consumer surplus falls from (1 + b + c + d) to b and producer surplus falls from (e + f + g + h) to h. Government revenue is (b + c + e + g) and deadweight loss is (d + f)

b) Tax burden falls on the consumers shown by area of loss in consumer surplus (orange shaded region) and tax burden falls on the producers shown by area of loss in producer surplus (green shaded region)

c) Tax burden falls more consumers because they are inelastic side. The inelastic side of the market is not able to reduce the consumption in same proportion as the price is increased so that their spending is not reduced proportionately and they end up paying a greater tax burden