Suppose the inverse demand curve for good A is given by the equation P A = 10 - Q A /10, and the supply curve is perfectly elastic (horizontal) at $1. Good A is presently taxed at $2 per unit. Good B (which is independent of good A) has an inverse demand curve, P B = 5 - Q B /20, and is also perfectly elastic at $1. Good B is untaxed.
(A) How much tax revenue is collected and what is the excess burden of the $2 tax on A?
(B) How much revenue is collected if the tax on good A is reduced to $1 per unit and good B is
taxed at $1 per unit?
(C) What is the total excess burden of taxing both goods at $1 per unit?
(D) Which tax system is preferable from the point of view of economic efficiency?
(A) Tax revenue = (2)(70) = 140. Excess burden = (1/2)(2)(20) = 20.
(B) Total tax revenue = (1)(80) + (1)(60) = 140.
(C) Total excess burden = (1/2)(20)(1) + (1/2)(10)(1) = 15.
(D) Both systems raise the same amount of tax revenue, 140, but the second system does it
with less excess burden, 15 < 20. Therefore, the second system would be more efficient.
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