Chapter 7: Taxes - Consumer and Producer Surplus + Elasticity

Question 1

A tax would ____ reduce/increase consumer and producer surplus

Answer 1

reduce

Question 2

A tax creates government revenue. What does that mean for consumer and producer surplus?

Answer 2

• a transfer from consumer surplus and producer surplus to government revenue

Question 3

Why does tax create deadweight loss?

Answer 3

• the amount of surplus that would have been generated by transactions that now do not take place because of the tax

Question 4

Tax reduces CS and PS graph

Answer 4

Question 5

What are administrative costs of a tax?

Answer 5

• the resources used by governments to collect the tax, and by the taxpayers to pay it, over and above the amount of tax, as well as to evade it
• not seen in the model

Question 6

What is the SUM of deadweight loss and administrative costs?

Answer 6

• total inefficiency caused by a tax

Question 7

How should a tax system generally be designed?

Answer 7

• other things equal, a tax system should be designed to minimize the total inefficiency it imposes on society

Question 8

When is DWL large in terms of the demand curve?

Answer 8

• when demand is elastic
  better to have inelastic demand

Question 9

When is DWL larger in terms of the supply curve?

Answer 9

• when supply is elastic

Question 10

How should one minimize the efficiency costs of taxation in terms of the supply and demand curves? (2)

Answer 10

• choose to tax only those goods for which demand or supply, or both, are relatively inelastic
• for these goods, a tax has little effect on behaviour because behaviour is relatively unresponsive to changes in the price

Question 11

What happens if demand is perfectly inelastic (vertical curve)? (2)

Answer 11

• quantity demanded is unchanged by the imposition of the tax
• therefore no DWL

Question 12

What happens if supply is perfectly inelastic (vertical curve)?

Answer 12

quantity supplied is unchanged by the tax and there is no DWL