Correct Answers
In-Class Exercise #1
Economics 139

• A. On both graphs, draw a vertical line from the intersection of the demand curve and the upper supply curve down to the lower supply curve. The deadweight loss is the triangle bounded by this line, the demand curve, and the lower supply curve. Its area is 40 on the Snickers graph and 200 on the Kitkat graph. Total deadweight loss is 240.
• B. The tax revenue box is bounded by the same vertical line as in question 1, the two supply curves, and the vertical axis. The area is 400 on the Snickers graph and 480 on the Kitkat graph; total tax collections are 880.
• C. The new supply curve is a horizontal line at P=70, ten cents above the old one at P=60, and 3 cents above the pretax supply curve at P=40. Price rises by 10 cents; the whole tax is passed on to consumers, and sellers pay none of it. (This is because the supply curve is perfectly elastic.)
• D. The new deadweight loss is 90, and the tax now collects 540, for an increase of 140. Optional question: Consumers have lost a total of 190. Producers haven't lost anything because they had no surplus to start with, again because the supply curve is perfectly elastic.
• E. The new supply curve is a horizontal line at P=50, ten cents below the old one at P=60 and ten cents above the pretax supply curve at P=40. Price falls by 10 cents, buyers receive all the gain, sellers receive none.
• F. The new deadweight loss is 50, and the new revenue is 340, which is 140 less than before. Optional question: Consumers gained 290 and producers gained nothing.
• G. Total revenue is the same as before: 540+340=880. Deadweight loss has fallen; 90+50=140, it is now 100 less than it was previously.
• H. Snickers consumers bear the incidence; they lose a total of 190 to the tax. Kitkat consumers get the gains, coming out 290 ahead. Note that the gains to the Kitkat consumers are larger than the losses to the Snickers consumers. This happens because the deadweight loss has fallen and tax revenues (and produced surplus, which is 0) are unchanged; the gain from reducing the deadweight loss ends up with the consumers. The gain of 100 in total consumer surplus (290 gain by Kitkat consumers - 190 lost to Snickers consumers) is exactly equal to the drop of 100 in deadweight loss.