Question

In: Economics

The federal government currently imposes an excise tax on air travel. That is, airlines are required...

The federal government currently imposes an excise tax on air travel. That is, airlines are required to pay a tax per passenger on each flight. Suppose this tax is equal to $4.00 per passenger.

a. Using the model of demand and supply shows what the market for air travel would look like without the tax. Identify on your graph the market price, the number of passengers flown, consumer surplus, and producer surplus.

b.Using the model of demand and supply illustrates the impact of the $4.00 tax on the market for air travel. Identify on your graph the price consumers pay, the price producers receive, the number of passengers flown, consumer surplus, producer surplus, the tax revenue generated by the tax, and the deadweight loss. How does each of these compare to the pre-tax case in (a)?

Solutions

Expert Solution

(a) In following graph, D0 and S0 are initial demand and supply curves, intersecting at point E with initial equilibrium price P0 and quantity Q0. Consumer surplus (CS = area between demand curve and price) is area AEP0 and producer surplus (PS = area between supply curve and price) is area BEP0. Total surplus (TS = CS + PS) is area AEB.

(b) The tax on airlines will shift supply curve leftward to S1, intersecting D0 at point F. Price paid by consumers increases to P1, price received by producers decrease to P2 (where P1 - P2 = Unit tax = $4) and quantity decreases to Q1. New CS is area AFP1, so CS is lower by area P0EFP1. New PS is area BGP2, so PS is lower by area P0EGP2. Tax revenue is area P1FGP2. New TS is sum of CS, PS and tax revenue, equal to area AFGB. Deadweight loss is area EFG.


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