Question

Kyle places a $10 value on a glass of red wine, and Keith places an $8 value on it. If there is no tax on glasses of red wine, the price of a glass of red wine reflects the cost of making it. The equilibrium price for a glass of red wine is $6. Suppose the government levies a tax of $3 on each glass of red wine, and the equilibrium price of a glass of red wine increases to $9. How much tax revenue is collected?

Answer 1

Answer:

D. Fallen by more than the tax revenue, the tax has a dead weight loss.

Explanation:

First, the Multiple options for the question:

A. Fallen by Exactly the amount of the tax revenue, the tax has no deadweight loss

B. Fallen by less than the tax revenue, the tax has no deadweight loss

C. Increased by less than the tax revenue, the tax has a deadweight loss

D. Fallen by more than the tax revenue, the tax has a dead weight loss.

Solution:

The first step is to determine Kyle and Keith's total consumer surplus before tax.

The consumer surplus is calculated as follows: The Amount each is willing to pay - The Market/Equilibrium Price

Kyle's consumer surplus= $10- $6 = $4

Keith's consumer surplus= $8-$6= $2

Total of their  Consumer surplus = $6

Step 2: Calculate the Consumer Surplus after the tax levied by the government is applied to the market price

Market price ($6) + Tax ($3) = $9

Kyle's consumer surplus= $10- $9= $1

However, Keith is only willing to pay $8 so there is no consumer surplus.

Based on this step 2: The consumer surplus total after tax is applied is actually lower than the tax revenue of $3, therefore there is a deadweight loss.