Question

Governments often place so-called sin taxes on goods or services such as cigarettes and alcohol. These kinds of taxes are popular with politicians because they are usually more palatable to voters than income taxes. 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. 0 20 40 60 80 100 120 140 160 180 200 40 36 32 28 24 20 16 12 8 4 0 PRICE (Dollars per bottle) QUANTITY (Bottles) Demand Supply Graph Input Tool Market for Rum Quantity (Bottles) 80 Demand Price (Dollars per bottle) 24.00 Supply Price (Dollars per bottle) 16.00 Tax Wedge (Dollars per bottle) 8.00 Suppose the government imposes an $8-per-bottle tax on suppliers. At this tax amount, the equilibrium quantity of rum is 80 bottles, and the government collects $640 in tax revenue. Now calculate the government's tax revenue if it sets a tax of $0, $8, $16, $20, $24, $32, or $40 per bottle. (Hint: To find the equilibrium quantity after the tax, adjust the “Quantity” field until the Tax Wedge 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. Laffer Curve 0 4 8 12 16 20 24 28 32 36 40 1600 1440 1280 1120 960 800 640 480 320 160 0 TAX REVENUE (Dollars) TAX (Dollars per bottle) Suppose the government is currently imposing a $24-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 $16 per bottle, and a tax of $32 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 12×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.) Deadweight Loss 0 4 8 12 16 20 24 28 32 36 40 1600 1440 1280 1120 960 800 640 480 320 160 0 DEADWEIGHT LOSS (Dollars) TAX (Dollars per bottle) As the tax per bottle increases, deadweight loss .

Answer 1

When the demand and the supply curve is unit elastic the tax burden is shared between the buyers and the sellers.

Suppose the government imposes $8 per bottle tax on suppliers. As a result, the price buyers paid equals to $24 and price sellers recieve equals to $16, At this tax amount, the equilibrium quantity of rum bottles is 48 bottles and government collects ($8*48) $384 in tax revenue.

Suppose the government is currently imposing a $24-per-bottle tax on rum.

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

Answer: True

It can be seen from the table the at the tax rate $24 , the revenue is $576 and when the tax rate is decreased to $20 , the tax revenue is $600.

Deadweight loss at no tax is none.

Deadweight loss at $16 tax is given by the area of triangle between new and old equilibrium

Area of deadweight tax = 1/2*b*h = 1/2 *(tax )*( old equilibrium - new equilibrium)

= 1/2 *16*(60-36)

= 192

Area of deadweight tax at $32 = 1/2*b*h = 1/2 *(tax )*( old equil- new equil)

= 1/2*32*(60-12)

= 768

As the tax per bottle increases, deadweight loss increases.