Suppose the inverse demand curve for good A is given by the equation PA = 10 – QA/10, and the supply curve is perfectly elastic (horizontal) at $1. Good A is presently taxed at $2 per unit. Good B (which is independent of good A) has an inverse demand curve, PB = 5 – QB/20, and is also perfectly elastic at $1. Good B is untaxed. Required:
a. How much tax revenue is collected and what is the excess burden (deadweight loss) of the $2 tax on A? hint: Supply = Demand. You get the quantity and the price for each good. Then, for good A, add price and tax (1+2) and sole again to get the quantity under tax . This quantity will give you tax revenue.
b. How much revenue is collected if the tax on good A is reduced to $1 per unit and good B is taxed at $1 per unit? Same process as above. Hint: But this time with a new tax. The excess burden is the deadweight loss. = ½ * tax * quantity
c. What is the total excess burden (deadweight loss) of taxing both goods at $1 per unit?
d. Which tax system is preferable from the point of view of economic efficiency?