1. Define deadweight loss.

• a fall in total surplus that results from a market distortion
  • Total Surplus = Tax Revenue + Consumer Surplus + Producer Surplus
  • Welfare with a tax:
    • Tax revenue = positive. Consumer surplus & producer surplus = negative. Therefore, losses to buyers and sellers exceed govt's gains--- this is the deadweight loss
  • impacted by the elasticity of supply and demand
• examples: as tax increases, size of deadweight loss increases

2. Where does it exist on the supply and demand curve?

• The deadweight loss exists in boxes c & e (look on page 164).

• Boxes a, b, d, and f make up the total surplus. However, as the tax pushes up the price, the consumer surplus decreases from P1 to Pb (getting rid of box c). The tax pushes the producer surplus down from P1 to Ps (reducing box e). So, thetriangle on the right, made from boxes c and e,is thedeadweight.

3. How does a tax affect welfare of market participants?

consumer and producer surpluses. This in turn means that both consumers and producers are not receiving the full benefits available at the equilibrium price.

4. Explain how elasticity of supply affects deadweight loss.

• when supply is inelastic, the deadweight loss of a tax is much smaller because of the shape of the steeper supply curve, which allows less space for the deadweight loss
• More elastic supply will create a greater deadweight loss sicne the supply curve is flatter and will allow more space for the deadweight loss

5. Explain how elasticity of demand affects deadweight loss

• when demand is inelastic, the deadweight loss will be smaller sicne the demand curve is steeper
• when demand is more elastic, the deadweight loss will be greater since the demand curve is flatter

6. The demand for beer is more elastic than the demand for milk. Would a tax on beer or a tax on milk have a larger deadweight loss? Why?

• Since the demand for beer is more elastic than milk, the deadweight loss will be larger foir a tax on beer because the demand curve will be much flatter than that of milk, allowing more space for the deadweight loss

7. How is tax revenue impact by a small tax and why Tax revenue is usually not very large since the tax will not bring as much profit. But the deadweight loss from a small tax is kept at a minimum, so it may be more efficient than a large tax.

8. How is tax revenue impacted by a medium tax and why. A medium tax will yield a fair amount of tax revenue since the tax will be medium sized, but the deadweight loss will also be considerably larger. However, a medium tax may be preferred by governments in soem cases because of the greater profits they bring than a small tax
9. How is tax revenue impacted by a large tax and why.

If a large tax is imposed on a good the total revenue gained from the tax may be less than the deadweight loss caused towards the good that was taxed. A larger tax is more likely to be inneficient than a smaller tax.

The higher tax drastically reduces the size of the market. For a very large tax no revenue would be raised, because people would stop buying and selling the good altogether.

10. What do tax planners have to play particular attention to when taxing a product?

Elasticiy: When supply is relatively inelastic the deadweight loss of a tax is small. When supply is relatively elastic, the deadweight loss of a tax is large. Also when demand is relatively inelastic, the deadweight loss of a tax is small while when demand is relatively elastic, the deadweight loss of a tax is large.

11. Explain the significance of the Laffer Curve.

• The Laffer curve shows that tax revenue first rises, then falls.
• It shows how tax rates affect tax revenues
• high tax rates create disincentive to work
• applies best to the richest, who pay very high tax rates. When their tax rates are cut, revenues tend to rise
  

12. Using the text, what is supply-side economics?

- the cut in tax rates that was intended to encourage people to increase the quantity of labor they supplied