APPLICATION: TAX and TRADE

(You should be able to explain your answers in multiple-choice questions)

TAX

1. A tax on a good has a deadweight loss if

a. the reduction in consumer and producer surplus is greater than the tax revenue.

b. the tax revenue is greater than the reduction in consumer and producer surplus.

c. the reduction in consumer surplus is greater than the reduction in producer surplus.

d. the reduction in producer surplus is greater than the reduction in consumer surplus.

2. donna runs an inn and charges $300 a night for a room, which equals her cost. Sam, harry, and
Bill are three potential customers willing to pay $500, $325, and $250, respectively. when the
government levies a tax on innkeepers of $50 per night of occupancy, donna raises her price to
$350. the deadweight loss of the tax is

a. $25.

b. $50.

c. $100.

d. $150.

3. Sophie pays Sky $50 to mow her lawn every week. when the government levies a mowing tax
of $10 on Sky, he raises his price to $60. Sophie continues to hire him at the higher price. what is
the change in producer surplus, change in consumer surplus, and deadweight loss?

a. $0, $0, $10

b. $0, −$10, $0

c. 1$10, −$10, $10

4. if a policymaker wants to raise revenue by taxing goods while minimizing the deadweight
losses, he should look for goods with _________ elasticities of demand and _________
elasticities of supply.

a. small; small

b. small; large

c. large; small

d. large; large

5. in the economy of Agricola, tenant farmers rent the land they use from landowners. if the
supply of land is perfectly inelastic, then a tax on land would have _________ deadweight
losses, and the burden of the tax would fall entirely on the _________.

a. sizable; farmers

b. sizable; landowners

c. no; farmers

d. no; landowners

6. Suppose the demand for grape jelly is perfectly elastic (because strawberry jelly is a good
substitute), while the supply is unit elastic. A tax on grape jelly would have _________
deadweight losses, and the burden of the tax would fall entirely on the _________ of grape jelly.

a. sizable; consumers

b. sizable; producers

c. no; consumers

d. no; producers
7. the laffer curve illustrates that, in some circumstances, the government can reduce a tax on a
good and increase the

a. price paid by consumers.

b. equilibrium quantity.

c. deadweight loss.

d. government’s tax revenue.

8. eggs have a supply curve that is linear and upward-sloping and a demand curve that is linear
and downward-sloping. if a 2 cent per egg tax is increased to 3 cents, the deadweight loss of the
tax (challenge: using algebra to show your answer!)

a. increases by less than 50 percent and may even decline.

b. increases by exactly 50 percent.

c. increases by more than 50 percent.

d. the answer depends on whether supply or demand is more elastic.

9. Peanut butter has an upward-sloping supply curve and a downward-sloping demand curve. if a
10 cent per pound tax is increased to 15 cents, the government’s tax revenue (challenge: using
algebra to show your answer!)

a. increases by less than 50 percent and may even decline.

b. increases by exactly 50 percent.

c. increases by more than 50 percent.

d. the answer depends on whether supply or demand is more elastic.

10. After economics class one day, your friend suggests that taxing food would be a good way to
raise revenue because the demand for food is quite inelastic. In what sense is taxing food a
“good” way to raise revenue? In what sense is it not a “good” way to raise revenue?
11. Hotel rooms in Smalltown go for $100, and 1,000 rooms are rented on a typical day.

a. To raise revenue, the mayor decides to charge hotels a tax of $10 per rented room. After the
tax is imposed, the going rate for hotel rooms rises to $108, and the number of rooms rented falls
to 900. Calculate the amount of revenue this tax raises for Smalltown and the deadweight loss of
the tax.

b. The mayor now doubles the tax to $20. The price rises to $116, and the number of rooms
rented falls to 800. Calculate tax revenue and deadweight loss with this larger tax. Are they
double, more than double, or less than double your answers in part (a)? Explain.

TRADE

1. the country Autarka does not allow international trade. in Autarka, you can buy a wool suit for
3 ounces of gold. meanwhile, in neighboring countries, you can buy the same suit for 2 ounces of
gold. this suggests that

a. Autarka has a comparative advantage in producing suits and would become a suit exporter if it
opened up trade.

b. Autarka has a comparative advantage in producing suits and would become a suit importer if it
opened up trade.

c. Autarka does not have a comparative advantage in producing suits and would become a suit
exporter if it opened up trade.

d. Autarka does not have a comparative advantage in producing suits and would become a suit
importer if it opened up trade.

2. the nation of openia allows free trade and exports steel. if steel exports were prohibited, the
price of steel in openia would be _________, benefiting steel _________.

a. higher; consumers

b. lower; consumers

c. higher; producers
d. lower; producers

3. When the nation of ectenia opens itself to world trade in coffee beans, the domestic price of
coffee beans falls. Which of the following describes the situation?

a. domestic production of coffee rises, and ectenia becomes a coffee importer.

b. domestic production of coffee rises, and ectenia becomes a coffee exporter.

c. domestic production of coffee falls, and ectenia becomes a coffee importer.

d. domestic production of coffee falls, and ectenia becomes a coffee exporter.

4. When a nation opens itself to trade in a good and becomes an importer,

a. producer surplus decreases, but consumer surplus and total surplus both increase.

b. producer surplus decreases, consumer surplus increases, and so the impact on total surplus is
ambiguous.

c. producer surplus and total surplus increase, but consumer surplus decreases.

d. producer surplus, consumer surplus, and total surplus all increase.

5. if a nation that imports a good imposes a tariff, it will increase

a. the domestic quantity demanded.

b. the domestic quantity supplied.

c. the quantity imported from abroad.

d. the efficiency of the equilibrium.

6. Which of the following trade policies would benefit producers, hurt consumers, and increase
the amount of trade?

a. the increase of a tariff in an importing country

c. starting to allow trade when the world price is greater than the domestic price

d. starting to allow trade when the world price is less than the domestic price

7. The nation of Textilia does not allow imports of clothing. In its equilibrium without trade, a T-
shirt costs $20, and the equilibrium quantity is 3 million T-shirts. One day, after reading Adam
Smith’s The Wealth of Nations while on vacation, the president decides to open the Textilian
market to international trade. The market price of a T-shirt falls to the world price of $16. The
number of T-shirts consumed in Textilia rises to 4 million, while the number of T-shirts
produced declines to 1 million.

a. Illustrate the situation just described in a graph. Your graph should show all the numbers.

b. Calculate the change in consumer surplus, producer surplus, and total surplus that results from
opening up trade

8. Assume the United States is an importer of televisions and there are no trade restrictions. U.S.
consumers buy 1 million televisions per year, of which 400,000 are produced domestically and
600,000 are imported.

a. Suppose that a technological advance among Japanese television manufacturers causes the
world price of televisions to fall by $100. Draw a graph to show how this change affects the
welfare of U.S. consumers and U.S. producers and how it affects total surplus in the United
States.

b. After the fall in price, consumers buy 1.2 million televisions, of which 200,000 are produced
domestically and 1 million are imported. Calculate the change in consumer surplus, producer
surplus, and total surplus from the price reduction.

c. If the government responded by putting a $100 tariff on imported televisions, what would this
do? Calculate the revenue that would be raised and the deadweight loss. Would it be a good
policy from the standpoint of U.S. welfare? Who might support the policy?
d. Suppose that the fall in price is attributable not to technological advance but to a subsidy from
the Japanese government to Japanese industry of $100 per television. How would this affect your
analysis?