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ECON1210 24s Tutorial 6 Notes (Donald)

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28 views32 pages

ECON1210 24s Tutorial 6 Notes (Donald)

Uploaded by

mervyn2200
Copyright
© © All Rights Reserved
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ECON1210 Introductory microeconomics

2023-24 Semester 2
Tutorial 6 – Taxes and Subsidies

Teaching assistant: Donald Kwok


Roadmap
• Key concepts recall
• 1. Tax/ Subsidy wedge
• 2. Tax burden/ Share of subsidy benefit
• 3. Deadweight loss

• Discussion questions
• 6 Example questions
• 8 Past exam questions
• Techniques of unconstrained optimization

• Attendance exercise
Key concept recall – Taxes and Subsidies
Note In this course, we mainly focus on the discussion of per unit tax/subsidy
Remarks 1. Who pays (receives) the tax (subsidy) does not depend on whom
the tax (subsidy) is imposed in most cases.
• This is why we may use tax (subsidy) wedge to solve the problems

2. Who pays (receives) more of the tax (subsidy) does depend on


the relative elasticities of demand and supply.
• The less elastic side will pay (receive) a larger share of a tax (subsidy)

3. Taxation and subsidization shall normally create lost gains from


trade (i.e. deadweight loss) except under some extreme cases.
• Total economic surplus = CS + PS + tax revenue – subsidy expenditure
• Deadweight loss would be greater with more elastic demand/supply
Key concept recall – Taxes and Subsidies

Illustration of Remarks #2
- similar analysis applies to the case with a subsidy
Key concept recall – Taxes and Subsidies

Illustration of Remarks #3(1)

* be careful when looking this as the areas overlap


Key concept recall – Taxes and Subsidies

Illustration of Remarks #3(2)


Discussion questions
Q1
Discussion questions
Q1
Solution
Without subsidy: Equilibrium quantity = 60, Equilibrium price = 6.
Increase the quantity traded by 20 → New quantity traded = 80
Subsidy wedge approach: Subsidy = Ps – Pd = 8 − 4 = 4
Discussion questions
Q2
Discussion questions
Q2
Solution
Discussion questions
Q3
Discussion questions
Q3
Solution
After the implementation of a subsidy, equilibrium quantity will increase.
And, we know the relationship Subsidy expenditure = ∆CS + ∆PS + DWL

Using this relationship, we can compute that


Subsidy expenditure = 10000 + 15000 + 2500 = 27500

Given that the subsidy expenditure is $27500 and the amount of subsidy, we can
compute the equilibrium quantity after subsidization
= 27500/5 = 5500
Discussion questions
Q3
Solution
We can use the DWL to compute the increase in quantity due to the subsidy
DWL = ½ × ∆Q × subsidy
2500 = ½ × ∆Q × 5
∆Q = 1000
Hence, the equilibrium quantity before subsidization = 5500 – 1000 = 4500
Discussion questions
Q4-6
The government decides to impose a $2 tax for every unit of bio-fuel. The demand
and supply curves of bio-fuel are Qd = 16 − 2P and Qs = 3P – 4 respectively.

4. The quantity traded would be lowered to [Answer 4A] and the taxation creates a
loss in total economic surplus of [Answer 4B] dollars.

5. As a result of the tax, buyers will pay [Answer 5A] dollars more and sellers will
receive [Answer 5B] dollars less.

6. It tells that the supply [Answer 6].


A. is relatively elastic than the demand
B. is relatively inelastic than the demand
C. has the same elasticity as the demand
Discussion questions
Q4
Solution
Method 1 Solving by hand
Without tax: Equilibrium quantity Q* = 8, Equilibrium price P* = 4

With the imposition of tax, tax wedge approach: Pd – Ps = 2 or Ps = Pd – 2.

At the after-tax equilibrium, quantity supplied should be equal to quantity demanded.


16 – 2Pd = 3(Pd–2) – 4
Pd = 5.2
Hence, Ps = 3.2, Qd = Qs = 5.6

DWL = (tax × change in quantity)/2


Therefore, DWL = [2× (8–5.6)]/2 = 2.4
Discussion questions
Q4
Solution
Method 2 GeoGebra
Note that the market condition is exactly the same no matter the tax is imposed on
consumers or producers (even though we don’t know it).
• For example, assume that the tax is imposed on producers → parallel upward shift
in supply

Quantity traded = 5.6


DWL = 2.4
Discussion questions
Q5-6
Solution
Q5
• Buyers will pay (5.2 – 4) = 1.2 dollars more
• Sellers will receive (4 – 3.2) = 0.8 dollars less

Q6
Since the less elastic side will bear a larger tax burden, this implies that the demand
is less elastic than the supply (1.2 > 0.8).
A. is relatively elastic than the demand
Discussion questions
Past Exam Question 2023 Spring Final Q16
Discussion questions
Past Exam Question 2023 Spring Final Q16
Solution
Key point: The mid-point of a linear downward-sloping demand is revenue-maximizing!

Mid-point of original demand = (368, 14.9)


• x-intercept = 368 × 2 = 736 (point A), y-intercept = 14.9 × 2 = 29.8 (point B)
→ Use “Line” function to obtain the original demand

New demand: Shift original demand upwards by the amount of unit subsidy 5.8 dollars
• x-intercept = 879.25 (point D), y-intercept = 35.6 (point C)

Revenue-maximizing price = 35.6/2 = 17.8


Revenue-maximizing quantity = 879.25/2 = 439.62
Discussion questions
Past Exam Question 2023 Spring Final Q16
Solution
Discussion questions
Past Exam Question 2020 Fall Midterm Q37-41
Discussion questions
Past Exam Question 2020 Fall Midterm Q37-41
Solution
Q37
∆𝑄 𝑃
Consider Ed = ×
∆𝑃 𝑄

-0.6 = (1/-1) × (50/Q)


Q = 250/3 ≈ 83.33

Q38
Let Demand: P = a – Q and Supply: P = b + Q
Put P = 50 and Q = 250/3 into the demand and supply functions, we have
a = 400/3 and b = -100/3
Hence, Demand: P = 400/3 – Q and Supply: P = -100/3 + Q
Discussion questions
Past Exam Question 2020 Fall Midterm Q37-41
Solution
For illustration purpose, assume that the subsidy is distributed to consumers
Q38 (cont.) Q39
• Price paid by buyers = 47.6 Quantity increase by 2.4 units
• Price received by sellers = 52.4 (= 85.73 – 83.33)
Discussion questions
Past Exam Question 2020 Fall Midterm Q37-41
Solution
Q40
Combined increased in CS and PS = 405.76
Discussion questions
Past Exam Question 2020 Fall Midterm Q37-41
Solution
Q41
Total economic surplus increases with smaller unit subsidy
• DWL decreases → Change in DWL = -4.32
Discussion questions
Past Exam Question 2022 Spring Midterm Q41-42
Discussion questions
Past Exam Question 2022 Spring Midterm Q41-42
Solution
Q41
Without tax: Equilibrium quantity Q* = 36000, Equilibrium price P* = 56
At new Q = 36000 – 4800 = 31200, we have Pd = 75.2 and Ps = 51.2

With the imposition of tax, tax wedge approach:


t = Pd – Ps
t = 75.2 – 51.2
t = 24
Discussion questions
Past Exam Question 2022 Spring Midterm Q41-42
Solution
Q42
Note that t = Pd – Ps = (50000-Q)/250 – (20000+Q)/1000 = 180 – Q/200

Consider ½ × ∆Q × tax = DWL


½ × (36000 – Q) × (180 – Q/200) = 85000

Solve the quadratic equation using GeoGebra!


→ desired Q = 30169.05

Maximum tax = 180 – 30169.05/200 = 29.15


Discussion questions
Past Exam Question 2022 Spring Midterm Q41-42
Note
Students are required to know how to solve quadratic equations when there are
questions on setting DWL target, tax revenue target, and subsidy expenditure target.

• DWL target: 2020 Spring Midterm Q30-31 and 2022 Spring Midterm Q41-42 are
standard examples.
• Tax revenue target: 2022 Fall Midterm Q39-40 is a standard example.
• Subsidy expenditure target: 2021 Spring Midterm Q36-37, 2021 Summer Midterm
Q45-46 and 2023 Summer Midterm Q40-41 are standard examples.

Alternative experimental approach:


• Refer to GeoGebra workshop notes (2021 Summer Midterm Q46)
Discussion questions
Past Exam Question 2022 Spring Midterm Q41-42
Add What is the amount of unit tax such that government’s tax revenue is maximized?
There are several methods to optimize (i.e. maximize or minimize) an objective function:
1. GeoGebra
• Type the function directly in GeoGebra to find the extreme point

2. Axis of symmetry
• For quadratic functions in the form of y = ax2 + bx + c, the maximized/ minimized
point occurs at x = -b/2a

3. Method of completing the square


• Express in the vertex form of the quadratic function and find the corresponding “x”

4. Differentiation (knowledge in calculus is not required in this course)


𝜕f
• Apply the first order condition 𝜕𝑥 = 0 and find the corresponding “x”
Discussion questions
Past Exam Question 2022 Spring Midterm Q41-42
Add What is the amount of unit tax such that government’s tax revenue is maximized?
• 2022 Fall Midterm Q39-40 and 2023 Spring Midterm Q39-41 are standard examples.
Denote the government’s tax revenue by R(t).
Then R(t) = t × Q = t × (36000 – 200t) = -200t2 + 36000t

Techniques of unconstrained optimization


Mtd 1 attained at t = 90 → refer to screencap
Mtd 2 attained at t = -36000/[2(-200)] = 90
Mtd 3 Vertex form: R(t) = -200(t-90)2 + 1620000
→ attained at t = 90
𝑑𝑅
Mtd 4 = −400𝑡 + 36000
𝑑𝑡

By FOC, we have t = 36000/400 = 90


Thank you for joining the tutorial!
Best wishes for the midterm exam!

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