Econ 98-Chiu Taxes Worksheet Spring 2005 Name & SID: Date: Page 1 of 5 Taxes and perfectly competitive markets We have ignored the government’s role in the economy for a vast majority of the course. Now we will relax this assumption, and allow the government to intervene in the market. The rule of thumb is that, IF the demand and supply curves incorporate all the benefits and costs within a market, THEN government intervention almost always causes a DEADWEIGHT LOSS. Please keep in mind the assumptions that we are making while you are doing the questions. Ask yourself, how will my answers change if supply was perfectly inelastic? If supply was perfectly elastic? If demand was perfectly inelastic? If demand was perfectly elastic? 1. The following market for beer is initially in equilibrium. The government wants to raise tax revenue to compensate for the state’s large budget deficit. The government places a $1 per-unit tax on the market for beer. Assume the tax is on producers. Show graphically the effects of this excise tax. Label the price consumers pay after the tax as P1, the price the producers receive after the tax as P2, and the quantity of beer purchased after the tax as Q’. S D P Q 20 10 0 4 12Econ 98-Chiu Taxes Worksheet Spring 2005 Name & SID: Date: Page 2 of 5 2. Calculate numerical values for P1, P2, and Q’. 3. Calculate before-tax consumer surplus. 4. Calculate after-tax consumer surplus. 5. Calculate loss or gain in consumer surplus after the tax. 6. Calculate before-tax producer surplus. 7. Calculate after-tax producer surplus. 8. Calculate loss or gain in producer surplus after the tax. 9. How much tax revenue is collected?Econ 98-Chiu Taxes Worksheet Spring 2005 Name & SID: Date: Page 3 of 5 10. Calculate dead-weight loss before the tax. 11. Calculate dead-weight loss after the tax. 12. Calculate the consumer tax burden. 13. Calculate the producer tax burden. 14. Who has the largest tax burden? 15. Why does a $1 per-unit tax on producers not cause a $1 increase in the price that consumers pay for beer? Assume a downward sloping market demand curve and an upward sloping market supply curve. A complete answer should have both a graph and a few sentences.Econ 98-Chiu Taxes Worksheet Spring 2005 Name & SID: Date: Page 4 of 5 HELP SHEET S DS' A B C EF G D P Q Pa P1 P* Q*Q’ HPb P2 Practical Definitions: Pa is the reservation price for consumers in the market. Pa is also the highest price consumers are willing and able to buy. Pb is the lowest price for producers in the market. Pb is also the lowest prices producers are willing and able to sell. P* is the initial market price equilibrium before taxes. Q* is the initial market quantity equilibrium before taxes. P1 is the price that consumers pay after taxes. P2 is the price that producers receive after taxes. Q’ is quantity purchased and sold after taxes.Formulas: Tax Size = Pc - Ps Tax Revenue = (Pc - Ps)(Q1) Keep in mind that the government cannot tax something that is not sold or purchased. Therefore the government cannot tax up to Q*. CS = area above price paid by consumers, below demand curve, and up to quantity purchased. PS = area below price received by producers, above supply curve, and up to quantity sold. CS before taxes = A + B + C + F PS before taxes = D + E + G + H Deadweight loss = NoneCS after taxes = A PS after taxes = H Tax Revenue = B + C + D + E DWL = F + G Notice that taxes cause a deadweight loss to society.Econ 98-Chiu Taxes Worksheet Spring 2005 Name & SID: Date: Page 5 of 5 (Scratch
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