Question

3. Relationship between tax revenues, deadweight loss, and demandelasticity

The government is considering levying a tax of $100 per unit on suppliers of either leather jackets or smartphones. The supply curve for each of these two goods is identical, as you can see on each of the following graphs. The demand for leather jackets is shown by DLDL (on the first graph), and the demand for smartphones is shown by DSDS (on the second graph).

Suppose the government taxes leather jackets. The following graph shows the annual supply and demand for this good. It also shows the supply curve (S+TaxS+Tax) shifted up by the amount of the proposed tax ($100 per jacket).

On the following graph, use the green rectangle (triangle symbols) to shade the area that represents tax revenue for leather jackets. Then use the black triangle (plus symbols) to shade the area that represents the deadweight loss associated with the tax.

Leather Jackets MarketTax RevenueDeadweight Loss050100150200250300350400450500550600240220200180160140120100806040200PRICE (Dollars per jacket)QUANTITY (Jackets)DLSupplyS+Tax

Instead, suppose the government taxes smartphones. The following graph shows the annual supply and demand for this good, as well as the supply curve shifted up by the amount of the proposed tax ($100 per phone).

On the following graph, do for smartphones the same thing you did previously on the graph for leather jackets. Use the green rectangle (triangle symbols) to shade the area that represents tax revenue for smartphones. Then, use the black triangle (plus symbols) to shade the area that represents the deadweight loss associated with the tax.

Smartphones MarketTax RevenueDeadweight Loss050100150200250300350400450500550600240220200180160140120100806040200PRICE (Dollars per phone)QUANTITY (Phones)DSSupplyS+Tax

Complete the following table with the tax revenue collected and deadweight loss caused by each of the tax proposals.

If the Government Taxes...	Tax Revenue	Deadweight Loss
	(Dollars)	(Dollars)
Leather jackets at $100 per jacket
Smartphones at $100 per phone

Suppose the government wants to tax the good that will generate more tax revenue at a lower welfare cost. In this case, it should tax   because, all else held constant, taxing a good with a relatively   elastic demand generates larger tax revenue and smaller deadweight loss.

Answer 1

For Leather jacket market : Before tax : Equilibrium price = $140 and equilibrium quantity= 350 jackets.

After tax : Price consumers pay= $160 and price sellers receive = $60 , equilibrium quantity= 150 jackets.

Tax revenue = (100)(150)= $15000.

Deadweight loss = (0.5)(160-60)(350-150)= $10000.

For Smartphone market: Before tax : Equilibrium price = $150 and equilibrium quantity= 350 phones.

After tax : Price consumers pay = $220 and price sellers receive = $120 , equilibrium quantity = 300 phones.

Tax revenue = (100)(300)= $30,000.

Deadweight loss = (0.5)(210-120)(350-300)= $2500.

If the Government taxes..	Tax revenue (Dollars)	Deadweight loss (Dollars)
Leather jackets at $100 per jacket	15,000	10,000
Smartphones at $100 per phone	30,000	2500

Suppose the government wants to tax the good that will generate more tax revenue at a lower welfare cost. In this case, it should tax smartphones becaue all else held constant , taxing a good with a relatively less elastic demand generates larger tax revenue and smaller deadweight loss.