Question

a. In order to fund ongoing security, Prince Brad needs to raise revenue. To do this, he levies a tax of 10 pounds. The supply and demand is given by P=50-5Q and P=Q. Using a graph, calculate the government revenue, the change in producer and consumer surplus, and deadweight loss from this tax. Who bears the tax incidence?

b. There is a potential rebellion because of this new tax. Prince Brad meets with the leader of the rebellion who is named Chandler. Chandler says the new tax isn’t fair but a tax on luxury items imported from Europe would be a better thing to tax. Prince Brad, said that he has looked at all goods and ale is the optimal choice. Which part is right and why?

Answer 1

A) Pre tax equilibrium has 50 - 5Q = Q or Q = 50/6 = 8.33 and P = 8.33. After tax equilibrium has 50 - 5Q - 10 = Q or 40/6 = 6.67 and P = 6.67 (received by seller). Price paid by buyers =6.67 + 10 = 6.67

Change in CS = 0.5*(16.67 - 8.33)*(8.33 + 6.67) = 62.50

Change in PS = 0.5*(8.33 - 6.67)*(8.33 + 6.67) = 12.50

Revenue = tax * quantity = 10*6.67 = 66.7

DWL = 0.5*(8.33 - 6.67)*(16.67 - 6.67) = 8.3

Buyers has a greater loss in CS so they bear a greater burden

b) Prince brad is correct because luxury items are highly elastic and taxing them would not raise revenue. To earn more tax revenue goods with inelastic demand should be taxed which is true for ale.