Chapter 4, Problem 1TC

To determine

The effect of tax on economic efficiency.

Explanation of Solution

Tax is a unilateral payment made to the government from the public for various purposes. There are many types of taxes, such as income tax, wealth tax, and so forth, which constitute a major portion of the revenue of the government that can be used for making public expenditures. Economic efficiency is a situation where no one can be in a better position without hurting the other. In the case, economic efficiency is the situation where the marginal benefit (of the consumer) from the last unit produced is equal to the marginal cost of the production of the unit. This means that both of them will be the same and neither the consumer nor the producer can be in a better position. The sum of the consumer surplus and the producer surplus, which is the economic surplus, will be at its maximum.

Here, the tax imposed on the ride is 20%, which is equal to 6 pounds. This is because the equilibrium price was 30 pounds before the tax and the equilibrium quantity of the ride was 12,000. After the introduction of the tax on the ride, the price of the ride increased to 33 pounds, which is 3 pounds higher than the equilibrium rent. As a result of the new tax, the supply curve shifts upwards by the amount of tax imposed.

Thus, the supply vertically shifts by the tax amount of 6 pounds, and as a result, the quantity demanded decreases to 8,500 rides. The owner of the vehicles receives only 27 pounds, which is the reason for the decrease in the supply of the rides in the market. Thus, the consumer has to pay 33 pounds more than the equilibrium price, whereas the owner receives 3 pounds less than the equilibrium price received by him before the tax. Thus, the tax is equally shared among the consumer and the owner (by 3 pounds each). The economic efficiency is reduced by the tax because there will be deadweight loss in the economy due to the tax imposed by the government. The deadweight loss in the economy can be represented by the grey shaded area in the graph as follows:

The new quantity demanded after the introduction of the tax is 8,500 rides and the new price after the introduction of the tax is 33 pounds. The price actually received by the owner of the vehicle also reduces to 27 pounds; this means that both the owner and the consumer are paying 3 pounds each as tax. This shows that the tax burden is evenly distributed between the seller and the buyer. There is deadweight loss in the economy because of the tax and it can be denoted by the area shaded in grey colour on the graph.

Economics Concept Introduction

Concept introduction:

Tax: It is the unilateral payment made by the public towards the government. There are many different types of taxes in the economy, which includes income tax, property tax, professional tax, and so forth.

Economic efficiency: It is the situation where the economy is efficient. This means that the marginal benefit from the last unit produced is equal to the marginal cost of production and the economic surplus will be at is maximum.