ECON1131 Study Guide - Midterm Guide: Excise, Deadweight Loss, Federal Insurance Contributions Act Tax

Excise Taxes and Tax Revenue: The government pays attention to elasticity of demand when it selects goods and services on which to levy excise taxes (taxes levied on the production of a product or on the quantity fo the produc purchased). If a $1 tax is levied n a product and 10,000 units are sold, tax revenue will be $10,000 $1 X 10,000 units sold). If the government raises the tax to $1.50, but the higher prices that results reduces sales (quantity demanded) to 4000 because demand is elastic, tax revenue will decline to $6000 $1.50 X 4000 units sold). So a higher tax on a product that has an elastic demand will b ring in less tax revenue. In contrast, if demand is inelastic, the tax increase from $1 to $1.50 will boost tax revenue. For example, if sales fall from 10,000 to 9000, tax revenue will rise from $10,000 to $13,500 $1.50 X 9000 units). Little wonder that legislatures tend to seek out products such as liquor, gasoline, cigarettes, and phone services when levyingand raising taxes. Those taxes yield high tax revenues.

Question: Under what circumstance might a reduction of an excise tax actually produce more tax revenue?

Suppose you are hired by the Martin guitar company as an economic consultant. You estimate the demand for Martin guitars to be Q = 8000 - 2P. Suppose the supply of Martin Guitars is given by Q = -2000 +3P. What is the equilibrium price of Martin guitars?

1. What is the equilibrium quantity of Martin guitars?
2. What is the price elasticity of demand at the equilibrium price and quantity?
3. What is the price elasticity of supply at the equilibrium price and quantity?
4. For the next seven questions, suppose a per-unit excise tax of $40 per guitar is levied on the consumers.

• What price will sellers receive after the tax is levied?
• What price will consumers pay after the tax is levied?
• What percent of the tax will be paid by the consumers of Martin guitars? (give an answer between 0 and 100)
• What percent of the tax will be paid by the suppliers of Martin guitars? (give an answer between 0 and 100)
• How many guitars will be sold after the tax is imposed?
• How much consumer surplus do consumers get after the tax?
• What is the deadweight loss created by this tax?