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Chapter 7: Problem 7

The accompanying diagram shows the market for cigarettes. The current equilibrium price per pack is \(\$ 4,\) and every day 40 million packs of cigarettes are sold. In order to recover some of the health care costs associated with smoking, the government imposes a tax of \(\$ 2\) per pack. This will raise the equilibrium price to \(\$ 5\) per pack and reduce the equilibrium quantity to 30 million packs. The economist working for the tobacco lobby claims that this tax will reduce consumer surplus for smokers by \(\$ 40\) million per day, since 40 million packs now cost \(\$ 1\) more per pack. The economist working for the lobby for sufferers of second-hand smoke argues that this is an enormous overestimate and that the reduction in consumer surplus will be only \(\$ 30\) million per day, since after the imposition of the tax only 30 million packs of cigarettes will be bought and each of these packs will now cost \(\$ 1\) more. They are both wrong. Why?

Short Answer

Expert verified
Answer: The actual reduction in consumer surplus per day is \$10 million.

Step by step solution

01

Understanding consumer surplus

Consumer surplus is the difference between what consumers are willing to pay and what they actually pay for a good. In this case, we are looking at the change in consumer surplus before and after the government imposed the tax on cigarette packs.
02

Calculate consumer surplus before the tax

Before the tax, the equilibrium price per pack was \(\$ 4\) and there were 40 million packs sold per day. The total expenditure by the consumers on cigarettes can be calculated as \(4 \times 40 \, million = \$ 160\, million\) per day.
03

Calculate consumer surplus after the tax

After the tax, the equilibrium price per pack is \(\$ 5\) and there are 30 million packs sold per day. The total expenditure after the tax can be calculated as \(5 \times 30 \, million = \$ 150\, million\) per day.
04

Calculate the change in consumer surplus

The change in consumer surplus can be calculated by subtracting the consumer surplus after the tax from the consumer surplus before the tax: \(160\, million - 150\, million = \$ 10\, million\) per day.
05

Compare the change in consumer surplus with the economists' claims

Both economists are wrong because they both overestimated the reduction in consumer surplus. The economist working for the tobacco lobby claimed a reduction of \(\$ 40\, million\) per day, and the economist working for the lobby for sufferers of second-hand smoke claimed a reduction of \(\$ 30\, million\) per day. However, the actual reduction in consumer surplus is only \(\$ 10\, million\) per day.

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Most popular questions from this chapter

You work for the Council of Economic Advisers, providing economic advice to the White House. The president wants to overhaul the income tax system and asks your advice. Suppose that the current income tax system consists of a proportional tax of \(10 \%\) on all income and that there is one person in the country who earns \(\$ 110\) million; everyone else earns less than \(\$ 100\) million. The president proposes a tax cut targeted at the very rich so that the new tax system would consist of a proportional tax of \(10 \%\) on all income up to \(\$ 100\) million and a marginal tax rate of \(0 \%\) (no tax) on income above \(\$ 100\) million. You are asked to evaluate this tax proposal. a. For incomes of \(\$ 100\) million or less, is this proposed tax system progressive, regressive, or proportional? For incomes of more than \(\$ 100\) million? Explain. b. Would this tax system create more or less tax revenue, other things equal? Is this tax system more or less efficient than the current tax system? Explain.

Each of the following tax proposals has income as the tax base. In each case, calculate the marginal tax rate for each level of income. Then calculate the percentage of income paid in taxes for an individual with a pre-tax income of \(\$ 5,000\) and for an individual with a pre-tax income of \(\$ 40,000 .\) Classify the tax as being proportional, progressive, or regressive. (Hint: You can calculate the marginal tax rate as the percentage of an additional \(\$ 1\) in income that is taxed away.)a. All income is taxed at \(20 \%\). b. All income up to \(\$ 10,000\) is tax-free. All income above \(\$ 10,000\) is taxed at a constant rate of \(20 \%\). c. All income between \(\$ 0\) and \(\$ 10,000\) is taxed at \(10 \%\). All income between \(\$ 10,000\) and \(\$ 20,000\) is taxed at \(20 \%\). All income higher than \(\$ 20,000\) is taxed at \(30 \%\). d. Each individual who earns more than \(\$ 10,000\) pays a lump-sum tax of $\$ 10,000\(. If the individual's income is less than \)\$ 10,000$, that individual pays in taxes exactly what his or her income is. e. Of the four tax policies, which is likely to cause the worst incentive problems? Explain.

In each of the following cases involving taxes, explain: (i) whether the incidence of the tax falls more heavily on consumers or producers, (ii) why government revenue raised from the tax is not a good indicator of the true cost of the tax, and (iii) how deadweight loss arises as a result of the tax. a. The government imposes an excise tax on the sale of all college textbooks. Before the tax was imposed, 1 million textbooks were sold every year at a price of \$50. After the tax is imposed, 600,000 books are sold yearly; students pay \(\$ 55\) per book, \(\$ 30\) of which publishers receive. b. The government imposes an excise tax on the sale of all airline tickets. Before the tax was imposed, 3 million airline tickets were sold every year at a price of \(\$ 500\). After the tax is imposed, 1.5 million tickets are sold yearly; travelers pay \(\$ 550\) per ticket, \(\$ 450\) of which the airlines receive. c. The government imposes an excise tax on the sale of all toothbrushes. Before the tax, 2 million toothbrushes were sold every year at a price of $\$ 1.50$. After the tax is imposed, 800,000 toothbrushes are sold every year; consumers pay \(\$ 2\) per toothbrush, \(\$ 1.25\) of which producers receive.

The United States imposes an excise tax on the sale of domestic airline tickets. Let's assume that in 2013 the total excise tax was \(\$ 6.10\) per airline ticket (consisting of the \(\$ 3.60\) flight segment tax plus the $\$ 2.50$ September 11 fee). According to data from the Bureau of Transportation Statistics, in 2013, 643 million passengers traveled on domestic airline trips at an average price of \(\$ 380\) per trip. The accompanying table shows the supply and demand schedules for airline trips. The quantity demanded at the average price of \(\$ 380\) is actual data; the rest is hypothetical. a. What is the government tax revenue in 2013 from the excise tax? b. On January 1, 2014, the total excise tax increased to \(\$ 6.20\) per ticket. What is the quantity of tickets transacted now? What is the average ticket price now? What is the 2014 government tax revenue? c. Does this increase in the excise tax increase or decrease government tax revenue?

The U.S. government would like to help the Americar auto industry compete against foreign automaker: that sell trucks in the United States. It can do this by imposing an excise tax on each foreign truck sold in the United States. The hypothetical pre-tax demand anc supply schedules for imported trucks are given in the accompanying table. a. In the absence of government interference, what is the equilibrium price of an imported truck? The equilibrium quantity? Illustrate with a diagram. b. Assume that the government imposes an excise tax of \(\$ 3,000\) per imported truck. Illustrate the effect of this excise tax in your diagram from part a. How many imported trucks are now purchased and at what price? How much does the foreign automaker receive per truck? c. Calculate the government revenue raised by the excise tax in part b. Illustrate it on your diagram. d. How does the excise tax on imported trucks benefit American automakers? Whom does it hurt? How does inefficiency arise from this government policy?
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