Question

Charlize Theron conquered the peaceful land of Rombus as the people in this land actually agreed with the Mirror that Kristen Stewart is prettier than Charlize. You are now the economic advisor for Charlize the Supreme Overlord of Rombus. All people of Rombus really really love eating chicken nuggets and the demand of chicken nuggets is highly inelastic. The supply of chicken nuggets is fairly elastic. Charlize hates chicken nuggets as they generally look like Kristen. The general public is angry about being conquered and Charlize wants to institute a policy to stop chicken nugget sales without angering the people. Charlize wants to implement either one of two grand ideas. Her first idea is to place a large tax on the sales of chicken nuggets to provide a disincentive for producers to sell chicken nuggets. Her second idea is to place a very low price ceiling on chicken nuggets. This price ceiling would force chicken nugget prices to be far lower than the current market clearing price for chicken nuggets. She believes implementing either policy will force chicken nugget producers out of industry and shift public anger regarding the reduction of chicken nuggets onto the producers and not her. This assignment is assigned to gauge your writing ability. We would like to ensure that students can write and provide an explanation of economic concepts at a college level. Many pages can be spent writing about the topic described above. Nevertheless, I would like to examine if you can provide a focused presentation in a short written assignment. Please write a short essay (No more than 1.5 pages written without diagrams and tables) that you would present to the Overlord summarizing your analysis of the effect of both policies. For the analysis of the taxation policy, please include an analysis of (1) initial incidence of the tax and (2) burden of the tax. For the analysis of the price ceiling policy, please include an analysis of (1) the effect of a price ceiling on the market of chicken nuggets, and (2) whether there will be a shortage or surplus. Please also provide an analysis of welfare impact of implementing these policies. Please also provide Charlize with your recommendation of whether you believe if either one of the policies is a good idea given the current sensitive political environment and public views of her conquest of Rombus. Please include any tables and/or graphs you think are appropriate to support your conclusion.

Answer 1

Case 1: Sales tax is imposed on chicken nuggets

Consider figure 1. Without tax Qe quantity of chicken nuggets was sold and purchases at Pe price.

figure 1

When a sales tax is imposed on the sales of chicken nuggets, supply curve shifts fromS1 to S2. The quantity demanded still remains the same.

Price buyers pay increases from Pe to Pb. And price sellers get decreases from Pe to Ps. The price buyers pay has increased much more than the decrease in the price that sellers get. It is clearly visible in figure.

Tax imposed = Pb-Ps

Part of tax that buyers have to pay = Pb-Pe

part of tax that sellers have to pay = Pe-Ps

Since demand is inelastic it means buyers would still buy chicken nuggets at higher price. So buyers would bear the burden of the tax.

Case 2: price ceiling

figure 2

This case has been depicted in figure 2. When a price ceiling is imposed, price cannot be higher than Pc. Since the price has decreased, law of demand dictates that consumers would increase the quantity that they demand. Quantity demanded increases to Qd. But at the same time, sellers receive less price for their produce so they will decrease the quantity of chicken nuggets that they supply. This creates a shortage in chicken nuggets market at price Pc.

WELFARE IMPACT OF THESE POLICIES.

Consumer surplus= area above the price line and below the demand curve

Producer surplus= area below the price line and above the supply curve

CASE 1: sales tax

Deadweight loss = C+Z

governement revenue = B+Y

Case 2: price ceiling

Price ceiling increases consumer welfare, hence it is a better strategy to reduce the consumption of nuggets if  Charlize Theron wants to make consumers happy and at the same time decrease consumption of chicken nuggets.