Question

Ken places a $20 value on a cigar, and Mark places a $17 value on it. The equilibrium price for this brand of cigar is $15. Refer to Scenario 12-1. Suppose the government levies a tax of $3 on each cigar, and the equilibrium price of a cigar increases to $18. Because total consumer surplus has:_____.
a. fallen by more than the tax revenue, the tax has a deadweight loss.
b. fallen by less than the tax revenue, the tax has no deadweight loss.
c. fallen by exactly the amount of the tax revenue, the tax has no deadweight loss.
d. increased by less than the tax revenue, the tax has a deadweight loss.
e. increased by more than the tax revenue, the tax has no deadweight loss.

Answer 1

Because total consumer surplus has fallen by more than the tax revenue, the tax has a deadweight loss.

What is deadweight loss?

The deadweight loss of tax is the reduction in total surplus when a tax is levied on a good. Consumer surplus is the difference between the equilibrium price of a good and the value the consumer places on the good.

Initial consumer surplus = ($20 - $15) + ($17 - $15) = $7

New consumer surplus = ($20 - $18) = $2

Thus, there is a reduction in consumer surplus and there is a deadweight loss.

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