Question

Assume the supply curve for diapers is a typical, upward-sloping straight line, and the demand curve for diapers is a typical, downward-sloping straight line. Suppose the equilibrium quantity in the market for diapers is 1,000 per month when there is no tax. Then a tax of $0.50 per diaper is imposed. The effective price paid by buyers increases from $1.50 to $1.90 and the effective price received by sellers falls from $1.50 to $1.40. The government’s tax revenue amounts to $475 per month. Which of the following statements is correct?A) After the tax is imposed, the equilibrium quantity of diapers is 900 per month.B) The tax causes a decrease in consumer surplus of $380.C) The demand for diapers is more elastic than the supply of diapers.D) The deadweight loss of the tax is $12.50.

Answer 1

Answer: The following statement is correct: The dead-weight loss of the tax is $12.50.

We can compute Dead-weight loss as :

Dead-weight loss = $\frac{1}{2}$× [Quantity before tax - Quantity after tax]×[$Price_{buyer}$ - $Price_{seller}$]

∵ Tax revenue= Tax × Quantity after tax

⇒ Quantity after tax = $\frac{475}{0.50}$

⇒Quantity after tax = 950

∴ Dead-weight loss = $\frac{1}{2}\times[1000- 950]\times[1.90-1.40]$

⇒ Dead-weight loss = 12.50

Therefore the correct option is (d)