Question

King Kanuta, the ruler of Nutting Atoll, does not particular care for OSPs. However, he and his subjects love coconuts. The Nutters’ demand for coconuts is ? ? = 1200 − 100 × ?, while the supply of coconuts in Nutting Atoll is ? ? = 100 × ?.

a. What is the equilibrium price and quantity in this competitive market? What is the consumer and the producer surplus?

b. One day, King Kanuta decides to tax his subjects in order to collect coconuts for the Royal Larder. The King requires that for each coconut that every subject consumes, the subject must first buy a voucher from the palace at price £2. Write down the wedge that this tax introduces between consumer and producer prices. What is the effective price that consumers pay per coconut that they consume, and how many coconuts do they consume? What is the consumer and producer surplus under the coconut tax? How much revenue does this tax raise and how is the tax burden distributed?

c. King Kanuta’s subjects resent paying the taxes to the King and there are alarming signs of revolution among the Nutters. As a reaction, the King changes the tax. Now, the shopkeepers who sell the coconuts are responsible for paying the tax. That is, for each coconut they sell they must buy a license at a price of £2. Write down the new wedge that this tax introduces between consumer and producer prices. How many coconuts are consumed by the Nutters after this change in tax structure, what is the new price they pay? How much revenue does this tax raise and how is the tax burden now distributed?

d. There has been a rat invasion in the Royal Larder and all of King Kanuta’s reserves are now lost. In desperation, he decides to increase taxes in order to replenish his beloved Larder. In particular, he now wants to require each transaction of coconuts to be taxed at a price of £4. What would be the new quantity of coconuts transacted? What would be the new tax revenue? Calculate the deadweight loss of this tax.

e. King Kanuta’s Grand-Vizier thinks that a tax of £4 will not be enough. He is instead advocating a tax of £8. What would be the tax revenue at a tax of £8? Calculate the deadweight loss of this tax. Compare your answers to part d. Is there anything surprising here?

f. Finally, Lafferiku (King Kanuta’s Royal cook), is pushing for an even bigger tax of £10 per coconut. In terms of revenue collected and deadweight loss, how would you argue against such a tax?

Answer 1