Syeda Umyma Faiz

ERP: 25895
Institute of Business Administration,
Karachi Principles of Microeconomics
Session: Fall 2022
Assignment # 4
Instructions: Show your calculations and graphs for the questions below. For essay
questions/questions asking for explanation/description, please submit answers using no
more than 5 lines (only computer written will be accepted). These questions are from the
Mankiw’s book, copying anything from the online resources may lead to expulsion from
the program. Therefore, do not try to copy the words or style of explanation from the web.
The plagiarism policy will be applied strictly and with full force. If you do refer to a source,
please provide proper citation, the best policy, however is to use your own words (the best
thing you can do to avoid any plagiarism). Please submit a hard copy on Saturday the 12th
November 2022.

1. Consider the market for rubber bands.

a. If this market has very elastic supply and very inelastic demand, how would the
burden of a tax on rubber bands be shared between consumers and producers? Use
the tools of consumer surplus and producer surplus in your answer.

In a market where the supply is very elastic and the demand is very inelastic, larger tax
burden will be borne by the consumers. This is because the consumer surplus is larger
than the producer surplus.

b. If this market has very inelastic supply and very elastic demand, how would the
burden of a tax on rubber bands be shared between consumers and producers?
Contrast your answer with your answer to part (a).

In a market where the supply is very inelastic and the demand is very elastic, larger tax
burden will be borne by the producers. This is because the producer surplus is larger than
the consumer surplus.

2. Suppose that the government imposes a tax on heating oil.

a. Would the deadweight loss from this tax likely be greater in the first year
after it is imposed or in the fifth year? Explain.

The deadweight loss will be greater in the fifth year than the first year of imposing
the tax. This is because the price elasticity of demand for the first is less than the
elasticity of demand in the fifth year. Due to increase in prices of heating oil after
imposition of tax, the consumers are likely to shift to other resources with the
passage of time. This will increase the elasticity of demand; hence the deadweight
loss will be greater.
 b. Would the revenue collected from this tax likely be greater in the first year
after it is imposed or in the fifth year? Explain.

As the deadweight loss is greater in the fifth year than in the first year, the tax revenue
will be greater in the first year than in the fifth year. The demand is more inelastic in
the first year, hence the quantity demanded does not fall as much as it does in the fifth
year. Thus, more tax revenue is generated in the first year.

3. 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. (Hint: The area of a triangle is ½ * base * height.)

Tax revenue: 10 x 900 = $9000

Deadweight loss: ½ x 10 x 100 = $500

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? Explain.

Tax revenue: 20 x 800 = $16000

Deadweight loss: ½ x 20 x 200 = $2000
The tax rate is doubled; however the tax revenue is les than double. The deadweight loss is
more than doubled. It can be concluded that higher tax rates leads to further market
inefficiency due to higher deadweight loss.