For this question, suppose the market for widgets is perfectly competitive and the government introduces a per-unit $1 tax on widgets. Post-tax, quantity of widgets sold in market equals 100. Why could the deadweight loss caused by the tax be greater than the tax revenue collected?

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Asked Dec 9, 2019
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For this question, suppose the market for widgets is perfectly competitive and the government introduces a per-unit $1 tax on widgets. Post-tax, quantity of widgets sold in market equals 100. Why could the deadweight loss caused by the tax be greater than the tax revenue collected?

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Expert Answer

Step 1

The loss of market equilibrium leads to decline in economy efficiency. This reduction in economic efficiency leads to dead weight loss in the economy.

Step 2

The imposition of per unit $1 tax creates a wedge between demand curve DD and supply curve SS as shown in the figure (1) below.

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sS Dead weight loss S1 Tax Tax revenue DD Quantity Figure (1) Price

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Step 3

The imposition of taxation discourages investment and production. As introduction of tax leads to decline in retained earnings of the business firms and fall in disposable income of the households. Due to this firms lower the output production. Also, households prefer...

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