Question

4. The Laffer curve

Government-imposed taxes cause reductions in the activity that is being taxed, which has important implications for revenue collections. To understand the effect of such a tax, consider the monthly market for cigarettes, which is shown on the following graph.

Use the graph input tool to help you answer the following questions. You will not be graded on any changes you make to this graph. Note: Once you enter a value in a white field, the graph and any corresponding amounts in each grey field will change accordingly.

Suppose the government imposes a $4-per-pack tax on suppliers.

At this tax amount, the equilibrium quantity of cigarettes is _______  packs, and the government collects $_______  in tax revenue.

Now calculate the government's tax revenue if it sets a tax of $0, $4, $8, $10, $12, $16, or $20 per pack. (Hint: To find the equilibrium quantity after the tax, adjust the "Quantity" field until the Tax equals the value of the per-unit tax.) Using the data you generate, plot a Laffer curve by using the green points (triangle symbol) to plot total tax revenue at each of those tax leve/s.

Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically.

Suppose the government is currently imposing a $12-per-pack tax on cigarettes.

True or False: The government can raise its tax revenue by decreasing the per-unit tax on cigarettes.

Consider the deadweight loss generated in each of the following cases: no tax, a tax of $8 per pack, and a tax of $16 per pack.

On the following graph, use the black curve (plus symbo/s) to illustrate the deadweight loss in these cases. 

(Hint: Remember that the area of a triangle is equal to 1/2 × Base × Height. In the case of a deadweight loss triangle found on the graph input tool, the base is the amount of the tax and the height is the reduction in quantity caused by the tax.)

Answer 1

At this tax equilibrium quantity is reduced to 48 packs and the revenue collected by the government is worth 4*48 = S192 For a tax of $0, there is no tax revenue For a tax of $4, tax revenue is 4*48 $192 For a tax of $8, tax revenue is 8*36 = $288 For a tax of $12, tax revenue is 12*24 = $288 For a tax of $16, tax revenue is 16*12 = $192 For a tax of $20, tax revenue is 20*0 = S0 The answer is False. If tax is reduced from 12 to 8, there is no change in tax revenue When tax is 0, there is no deadweight loss so it is 0 When tax is 8, quantity is reduced from 60 to 36 so that deadweight loss is 0.5*8*(60 36) $96 When tax is 16, quantity is reduced from 60 to 12 so that deadweight loss is 0.5*16*(60 - 12) S348 Hence, as tax increases deadweight loss increases.

Laffer curve 300 288 288 270 240 210 192 192 180 150 120 90 60 30 0 0 0 2 4 6 8 10 12 14 16 18 20 Tax rate anuaa xET

480 432 384 DWL 384 336 288 240 192 144 96 96 48 10 12 16 18 20 14 TAX (Dollars per pack) DEADWEIGHT LOSS (Dollars)