Question

A. In order to fund ongoing security operations in the Middle East, Prince John needs to raise revenue. He decides to levy a £5 excise tax on ale, for which the demand and supply can be given by P=40-4Q and P=Q respectively. Using a graph to illustrate your answers, calculate the government’s revenue, the change in producer and consumer surplus, and the deadweight loss from this tax. Who bears the incidence of the tax?

B. Faced with an armed insurrection over the new taxes, Prince John meets with the leader of the uprising, a brigand named Robin. Robin suggests that the new tax is not fair and that a tax on spices (luxury items imported from the East) would be a better good to tax. Prince John, with the efficiency of the kingdom ever on his mind, counters that he considered all goods and ale was the optimal choice for the tax. Which party is right and why?

Answer 1

A. P=40 - 4Q and P = Q

P = 40 - 4P or P=8

In the following figure, CS represents Consumer Surplus, PS represents Producer's Surplus, DWL represents Dead Weight Loss.

The buyers pay 10.5 and the sellers receive 5.5, the rectangular area shows the tax revenue.

Both the buyer as well as the seller bear the incidence of tax equally.

B. According to me, taxing the luxurious goods will be a preferable option because the tax burden won't be on the poor section of the society.