Question

If coffee costs $5.00/cup and tea costs $2.50/cup, and coffee is taxed at a rate of $1.00/cup and tea faces a 20% value tax, graph Matt’s choice set given his $200/week limit on spending on coffee and tea. What is the slope of this budget constraint in the presence of these taxes?

Answer 1

Initial cost of coffee is $5 per cup and coffee is taxed at a rate of $1 per cup

Coffee cost = $5 + $1 (After tax)

Coffee cost = $6.

Hence, the coffee cost after tax is $6

Initial cost of tea is $2.50 per cup and tea faces a 20% value tax.

Tea cost = $2.50 + (0.2) * ($2.50) (after tax)

Tea Cost = $2..50 + $0.5

Tea cost = $3

Hence the tea cost after tax is $3.

Budget constraint after tax: 6C + 3T = 200.

Slope of Budget constraint = -(Price of coffee after tax / Price of tea after tax)

Slope of budget constraint = -($6 / $3)

Slope of budget constraint = -2.

Note: We assume that Coffee measured on the X-axis and Tea measured on Y-axis.

Answer: Slope of the budget constraint in the presence of these taxes is -2