Question

1. Consider the city of Melray Beach, Florida where lower income people work for lawn care firms that provide lawn care for the homes of higher income people. Lawn care firms charge their customers $40 per hour. They keep $25 an hour for administrative costs and pay their workers $15 per hour. Like many luxury goods, assume the demand for lawn care services is sensitive to changes in price. Suppose the price elasticity of demand is 1.5. On the other hand, assume the supply of lawn care workers is not as responsive to changes in their wages. Suppose the price elasticity of worker supply is 0.5. Melray Beach is considering a tax of $8 per hour (20%) on lawn care services. After all, the city reckons higher income people can afford to pay the extra $8 per hour for lawn care services.

1. Of the $8 per hour tax, higher income households will pay $___________

                             and lawn care firms will pay $_____________________________.

Answer 1

(A)

Elasticity of demand (Ed) = 1.5

Elasticity of supply (Es) = 0.5

Tax amount = $8

Calculate the burden of tax on higher income households -

Burden of tax = Tax amount * [Es/(Ed+Es)]

Burden of tax = $8* [1/(1.5+0.5)]

Burden of tax = $8* 1/2= $4

Calculate the burden of tax on house cleaning

firms -

Burden of tax = Tax amount * [Ed/(Es+Ed)] Burden of tax = $8 * [1.5/(1.5+0.5)]

Burden of tax = $8*1.5/2= $6

Thus,

Of the $8 per hour tax, higher income firms will pay $6.

households will pay $4 and house cleaning