- The annual demand for liquor in a certain state is given by the following equation: Qd = 500,000 – 20,000P, where P is the price per gallon and Qd is quantity of gallons demanded per year. The supply of liquor is given by the equation: Qs = 30,000P. Solve for the equilibrium annual quantity and price of liquor. (2 points)
Suppose that a $1-per-gallon tax is levied on the price of liquor received by sellers. Use both graphic and algebraic techniques to show the impact of the tax on market equilibrium. Calculate the excess burden of the tax, the amount of revenue collected, and the incidence of the tax between buyers and sellers. (6 points)
- The price elasticity of demand for wine is estimated to be -1 at all possible quantities. Currently, 200 million gallons of wine are sold per year, and the price averages $6 per bottle. Assuming that the price elasticity of supply of wine is 1 and the current tax rate is $1 per bottle, calculate the current excess burden of the tax on wine. Suppose the tax per bottle is increased to $2 per bottle. What will happen to the excess burden of the tax as a result of the tax increase (compute it)? Under what circumstances can a doubling of the tax on wine actually improve resource use in the United States, despite the increase in the excess burden of the tax? (6 points)
- Suppose you had to design a system of taxation for a republic of the former Soviet Union that was transforming its economy into a modern Western-style mixed economy. What criteria would you consider to minimize the excess burden of the system of taxation? Explain. Why would a uniform system of sales taxes likely have a higher excess burden than a system of excise taxes in which tax rates varied among taxed products? What would be the possible distortions resulting from a tax system that taxed consumption of goods and services and did not tax leisure activities? Why would a very efficient tax system be unlikely to gain broad political support in the republic? (8 points)
- Our discussion on government spending on entitlements focused on unemployment insurance, social security, and healthcare. First, provide a single theoretical story for why these three forms of entitlements should be provided by public finance and policy. Second, what important difference(s) can be found with healthcare as compared to the other two that makes the healthcare provision through public finance and policy a very expensive venture? Explain. (8 points)
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