Chap 08

Chapter 8
Application: The Costs of Taxation

MULTIPLE CHOICE
.
In 1776, the American Revolution was sparked by anger over

a. the extravagant lifestyle of British royalty.
b. the crimes of British soldiers stationed in the American Colonies.
c. British taxes imposed on the American Colonies.
d. the failure of the British to protect American Colonists from attack by hostile Indians.
ANSWER: c.
British taxes imposed on the American Colonies.
TYPE: M KEY1: D OBJECTIVE: 1 RANDOM: Y
1
When Ronald Reagan ran for the office of President of the United States, he promised that, if elected,
he would work for
a. increased taxes on gasoline.
b. reduced State sales tax rates.
c. reduced Federal sales tax rates.
d. reduced Federal income tax rates.
ANSWER: d. reduced Federal income tax rates.
2
During Ronald Reagans eight years in office

a. income tax rates rose.
b. income tax rates fell.
c. he said, Read my lips: no new taxes.
d. the tax rate of high income taxpayers rose, but the tax rates of low income taxpayers fell.
ANSWER: b.
income tax rates fell.
3
When a tax is levied on a good

a. the quantity of the good sold will change.
b. the price of the good sold will change.
c. both price and quantity of the good sold will change.
d. neither price nor quantity of the good sold will change.
ANSWER: c.
both price and quantity of the good sold will change.
4
Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.
2Chapter 8/Application: The Costs of Taxation

.
A tax on a good
a. raises the price buyers pay and lowers the price sellers receive.
b. raises the price buyers pay and raises the price sellers receive.
c. lowers the price buyers pay and lowers the price sellers receive.
d. lowers the price buyers pay and raises the price sellers receive.
ANSWER: a.
raises the price buyers pay and lowers the price sellers receive.
5
Economic analysis uses which of the following to judge the effect of taxes on economic welfare?
a. government spending
b. consumer and producer surplus
c. equilibrium price and quantity
d. opportunity cost
ANSWER: b.
consumer and producer surplus
6
A tax levied on the supplier of a product shifts

a. the supply curve upward or to the left.
b. the supply curve downward or to the right.
c. the demand curve upward or to the right.
d. the demand curve downward or to the left.
ANSWER: a.
the supply curve upward or to the left.
TYPE: M KEY1: D SECTION: 1 OBJECTIVE: 1 RANDOM: Y
7
A tax levied on the buyers of a product shifts

a. the supply curve upward or to the left.
b. the supply curve downward or to the right.
c. the demand curve upward or to the right.
d. the demand curve downward or to the left.
ANSWER: d. the demand curve downward or to the left.
8
When a tax is levied on a good

a. both buyers and sellers are economically worse off.
b. sellers are worse off but not buyers.
c. buyers are worse off but not sellers.
d. neither buyers nor sellers are worse off.
ANSWER: a.
both buyers and sellers are economically worse off.
9
Chapter 8/Application: The Costs of Taxation3

This graph shows supply and demand in a free market.
. According to the graph, if the market is in equilibrium, consumer surplus is represented by area
a. A.
b. B.
c. C.
d. D.
ANSWER: b.
B.
TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 GRAPH FORMAT: M INSTRUCTION: 1 RANDOM: N
10
. According to the graph, when the market is in equilibrium, producer surplus is represented by area
a. A.
b. B.
c. C.
d. D.
ANSWER: c.
C.
11
. According to the graph, total economic surplus would be represented by area

a. A + B.
b. B + C.
c. C + D.
d. A + D.
ANSWER: b.
B + C.
12
TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 GRAPH FORMAT: M
RANDOM: N

. When a tax is levied on the sellers of a good
a. the supply curve shifts left (up) by less than the tax.
b. the supply curve shifts left (up) by more than the tax.
c. the supply curve shifts left (up) by an amount equal to the tax.
d. the supply curve does not shift when a tax is levied on sellers.
ANSWER: c.
the supply curve shifts left (up) by an amount equal to the tax.
TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 RANDOM: Y
13
. When a tax on a good is enacted,

a. buyers and sellers share the burden of the tax regardless of which it is levied on.
b. buyers always bear the full burden of the tax.
c. sellers always bear the full burden of the tax.
d. sellers bear the full burden if the tax is levied on them, but buyers bear the full burden if the tax is
levied on them.
ANSWER: a.
buyers and sellers share the burden of the tax regardless of which it is levied on.
TYPE: M KEY1: C SECTION: 1 OBJECTIVE: 1 RANDOM: Y
14
. A tax placed on a good

a. causes the price of the good to fall.
b. affects buyers of the good, but not sellers.
c. causes the size of the market for the good to shrink.
d. is usually borne entirely by the seller of the good.
ANSWER: c.
causes the size of the market for the good to shrink.
15
. When a tax is levied on a good

a. the market price falls because demand declines.
b. the market price falls because supply falls.
c. a wedge is placed between the price buyers pay and the price sellers receive.
d. the market price rises because demand falls.
ANSWER: c.
a wedge is placed between the price buyers pay and the price sellers receive.
16
. The benefit received by buyers in a market is measured by

a. consumer surplus.
b. producer surplus.
c. the amount buyers actually pay for the good.
d. the amount it costs producers to produce the good.
ANSWER: a.
consumer surplus.
17

. The benefit received by the government from a tax is measured by
a. deadweight loss.
b. tax revenue.
c. equilibrium price.
d. total surplus.
ANSWER: b.
tax revenue.
18
. The benefit received by the sellers of a good in a market is measured by

a. consumer surplus.
b. producer surplus.
c. the amount buyers pay for the good in excess of the amount the good is actually worth.
d. the amount it costs producers to produce the good.
ANSWER: b.
producer surplus.
19
. The benefit from a tax is measured by

a. the benefit received by those people who gain from governments expenditure of the tax revenue.
b. the cost of collecting (administering) the tax.
c. the interest saved because the government did not borrow the funds.
d. the governments surplus which is tax revenue minus government expenditures.
ANSWER: a.
the benefit received by those people who gain from governments expenditure of the tax
revenue.
20
. According to the graph, the equilibrium market price before the tax is imposed is:
a. P1.
b. P2.
c. P3.
d. impossible to determine.
ANSWER: a.
P1.
TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 GRAPH FORMAT: M RANDOM: Y
21
. According to the graph, the price buyers pay after the tax is
a. P1.
b. P2.
c. P3.
ANSWER: c.
P3.
RANDOM: Y
. According to the graph, the price sellers receive after the tax is
a. P1.
b. P2.
c. P3.
ANSWER: b.
P2.
RANDOM: Y
22
23

. According to the graph, consumer surplus before the tax was levied is represented by area
a. A.
b. A + B + C.
c. D + E + F.
d. F.
ANSWER: b.
A + B + C.
24
. According to the graph, producer surplus before the tax is represented by area
a. A.
b. A + B + C.
c. D + E + F.
d. F.
ANSWER: c.
D + E + F.
25
. According to the graph, after the tax is levied, consumer surplus is represented by area
a. A.
b. A + B + C.
c. D + E + F.
d. F.
ANSWER: a.
A.
26
. According to the graph, after the tax is levied, producer surplus is represented by area
a. A.
b. A + B + C.
c. D + E + F.
d. F.
ANSWER: d. F.
27
. According to the graph, the tax caused a reduction in consumer surplus represented by area
a. A.
b. B + C.
c. D + E.
d. F.
ANSWER: b.
B + C.
28
. According to the graph, the tax caused a reduction in producer surplus represented by area
a. A.
b. B + C.
c. D + E.
d. F.
ANSWER: c.
D + E.
29

. According to the graph, the benefits to the government (total tax revenue) is represented by area
a. A + B.
b. B + D.
c. D + F.
d. C + E.
ANSWER: b.
B + D.
30
. According to the graph, the total surplus (consumer, producer, and government) with the tax is
represented by area
a. A + B + C.
b. D + E + F.
c. A + B + D + F.
d. C + E.
ANSWER: c.
A + B + D + F.
31
. According to the graph, the loss in total welfare resulting from the levying of the tax is represented by
area
a. A + B + C.
b. D + E + F.
c. A + B + D + F.
d. C + E.
ANSWER: d. C + E.
32
. The loss in total surplus (economic welfare) resulting from a tax is called
a. the Federal deficit.
b. the Federal surplus.
c. deadweight loss.
d. inefficiency.
ANSWER: c.
deadweight loss.
33
. Deadweight loss is
a. the reduction in total surplus that results from a tax.
b. the loss of profit to businesses when a tax is imposed.
c. the reduction in consumer surplus when a tax is placed on buyers.
d. the decline in government revenue when taxes are reduced in a market.
ANSWER: a.
the reduction in total surplus that results from a tax.
34
. According to the graph, the equilibrium market price before the tax is imposed is
a. $16.
b. $12.
c. $8.
d. $4.
ANSWER: b.
$12.
35
. According to the graph, the price buyers pay after the tax is
a. $16.
b. $12.
c. $8.
d. $4.
ANSWER: a.
$16.
RANDOM: Y
. According to the graph, the price sellers receive after the tax is
a. $16.
b. $12.
c. $8.
d. $4.
ANSWER: c.
$8.
RANDOM: Y
36
37

. According to the graph, consumer surplus before the tax was levied equaled
a. $150.
b. $125.
c. $75.
d. $45.
ANSWER: b.
$125.
38
. According to the graph, producer surplus before the tax equaled

a. $150.
b. $125.
c. $75.
d. $45.
ANSWER: b.
$125.
39
. According to the graph, after the tax is levied, consumer surplus would be
a. $150.
b. $125.
c. $75.
d. $45.
ANSWER: d.
$45.
40
. According to the graph, after the tax is levied, producer surplus would be
a. $150.
b. $125.
c. $75.
d. $45.
ANSWER: d. $45.
41
. According to the graph, the reduction in consumer surplus caused by the tax would be
a. $100.
b.
$80.
c. $70.
d. $60.
ANSWER: b.
$80.
42
. According to the graph, the reduction in producer surplus caused by the tax would be
a. $100.
b. $80.
c. $70.
d. $60.
ANSWER: b.
$80.
43

. According to the graph, the benefits to the government (total tax revenue) would be
a. $150.
b. $120.
c. $100.
d. $80.
ANSWER: b.
$120.
44
. According to the graph, the total surplus (consumer, producer, and government) before the tax would
equal
a. $350.
b. $300.
c. $250.
d. $200.
ANSWER: c.
$250.
45
. According to the graph, the total surplus (consumer, producer, and government) with the tax would
equal
a. $240.
b. $230.
c. $220.
d. $210.
ANSWER: d. $210.
46
. According to the graph, the amount of deadweight loss in this market resulting from the levying of
the tax is
a. $20.
b. $30.
c. $40.
d. $50.
ANSWER: c.
$40.
47
Assume that Jane cleans Joes house weekly for $80. Joe would be willing to pay as much as $100 weekly
to have his house cleaned. Janes opportunity cost is $70.
. If Jane cleans Joes house, the consumer surplus is
a. $100.
b. $80.
c. $70.
d. $20.
ANSWER: d. $ 20.
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48

. If Jane cleans Joes house, the producer surplus is
a. $100.
b. $80.
c. $70.
d. $10.
ANSWER: d. $10.
49
. Assume that Joe is required to pay a tax of $40 when he hires someone to clean his house. Which of
the following is true?
a. Joe will now clean his own home.
b. Jane will continue to cleans Joes home but her producer surplus will decline.
c. Total economic welfare (consumer surplus plus producer surplus plus tax revenue) will increase.
d. Jane will continue to clean Joes home, but consumer surplus will decline.
ANSWER: a.
Joe will now clean his own home.
50
. Taxes may cause deadweight losses because

a. they transfer purchasing power to the government which always wastes money.
b. they prevent buyers and sellers from realizing some of the gains from trade.
c. marginal buyers and sellers leave the market causing the quantity sold to fall.
d. Both b and c are correct.
ANSWER: d. Both b and c are correct.
51
. Assume that a tax is levied on a good and that the government uses the revenue to clean up lethal
toxic waste that would cause irreparable harm to a large number of people. In this case there would
be
a. a decrease in consumer surplus to consumers of the taxed good.
b. a decrease in producer surplus to producers of the taxed good.
c. a probable increase in the total economic welfare of society.
d. All of the above are correct.
ANSWER: d. All of the above are correct.
52
. Assume that a tax is levied on a good and the government uses the funds to build statues of the
Governors of each of the 50 states. In this case there would be
a. a decrease in consumer surplus to consumers of the taxed good.
b. a decrease in producer surplus to producers of the taxed good.
c. a probable decrease in the welfare of society that exceeded the deadweight economic loss from
the tax.
53

Phil offers to do Dons housework for $20 per week. Dons opportunity cost of doing housework is $30 per
week, and Phils opportunity cost of doing housework is $10 per week.
. What will be Dons gain in consumer surplus as a result of the proposed transaction?
a. Don will gain $30 per week.
b. Don will gain $20 per week.
c. Don will gain $10 per week.
d. Don will gain no consumer surplus.
ANSWER: c.
Don will gain $10 per week.
54
. What will be Phils gain in producer surplus as a result of the proposed transaction?
a. Phil will gain $30 per week.
b. Phil will gain $20 per week.
c. Phil will gain $10 per week.
d. Phil will gain no producer surplus.
ANSWER: c.
Phil will gain $10 per week.
55
. The total gain in welfare due to the transaction described here is

a. $10 per week.
b. $20 per week.
c. $30 per week.
d. $40 per week.
ANSWER: b.
$20 per week.
56
. The deadweight economic loss from taxes

a. does not depend on tax rates.
b. is higher when tax rates are higher than when tax rates are lower.
c. is lower when tax rates are higher than when tax rates are lower.
d. does not depend on the slope of the demand curve.
ANSWER: b.
is higher when tax rates are higher than when tax rates are lower.
57
. The amount of deadweight loss from taxes depends on

a. the price elasticity of demand and supply.
b. how much of the tax revenue the government plans to spend.
c. the product the government is planning to tax.
ANSWER: a.
the price elasticity of demand and supply.
58

. The greater the elasticities of demand and supply
a. the smaller the deadweight loss from a tax.
b. the less intrusive a tax will be on a market.
c. the greater the deadweight loss from a tax.
d. the more equitable the distribution of a tax between buyers and sellers.
ANSWER: c.
the greater the deadweight loss of a tax.
59
. If the supply of a good is relatively elastic, changing the price causes

a. a relatively small change in the amounts that buyers are willing to buy.
b. a relatively small change in the amounts sellers are willing to sell.
c. a relatively large change in the amounts sellers are willing to sell.
d. no change in the amounts sellers are willing to sell.
ANSWER: c.
a relatively large change in the amounts sellers are willing to sell.
60
Assume that the demand for entertainment is more elastic than the demand for gasoline.
. Compared to the decline in purchases from a similar percentage tax on gasoline, we would expect
that a tax on entertainment will cause the quantity of entertainment purchased to decline
a. more.
b. less.
c. the same.
d. neither more nor less.
ANSWER: a.
more.
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61
. The tax levied on entertainment will cause the loss of consumer surplus to be
a. zero.
b. relatively large.
c. relatively small.
d. either small or large (depending on the elasticity of supply).
ANSWER: b.
relatively large.
62
. A tax levied on gasoline will cause the loss of consumer surplus to be

a. zero (because raising the price of gasoline has no effect on the amount purchased).
b. relatively large.
c. relatively small.
d. either small or large (depending on the elasticity of supply).
ANSWER: c.
relatively small.
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63

Assume that the supply of gasoline is relatively inelastic and the supply of entertainment is relatively
elastic.
. Compared to the decline in quantity from a similar percentage tax on entertainment, we would expect
a tax on gasoline to cause the quantity of gasoline produced to
a. change more.
b. change less.
c. change by the same amount.
d. change either more or less, depending on the elasticity of demand.
ANSWER: b.
change less
64
. A tax levied on entertainment will cause the loss of producer surplus to be

a. relatively large.
b. relatively small.
c. zero.
d. either small or large, depending on the elasticity of demand.
ANSWER: a.
relatively large.
TYPE: M KEY1: D SECTION: 2 OBJECTIVE: 2 INSTRUCTION: 5 RANDOM: Y
65
. Assume that the demand for salt is relatively inelastic and that the demand for orange juice is
relatively elastic. Compared to the deadweight loss from the same percentage tax on orange juice, the
deadweight loss from imposing a tax on salt would be
a. greater.
b. less.
c. neither greater nor less.
d. either greater or less.
ANSWER: b.
less.
66
. Economists generally agree that the most important tax in the U.S. economy is the tax on
a. property.
b. consumption.
c. labor.
d. income.
ANSWER: c.
labor.
67
. The social security tax is, primarily, a tax on

a. earnings from labor.
b. interest income.
c. real estate holdings.
d. consumption spending.
ANSWER: a.
earnings from labor.
68

. If the labor supply curve is nearly vertical
a. a tax on labor has a large deadweight loss.
b. a tax on labor has a small deadweight loss.
c. a tax on labor has little impact on the amount of work labor is willing to do.
d. Both b and c are correct.
69
. The marginal tax rate on labor income for many workers in the U.S. is almost
a. 30%.
b. 40%.
c. 50%.
d. 60%.
ANSWER: c.
50%.
70
. The greater the social pressure for mothers to be housekeepers and stay out of the labor force
a. the more elastic the supply of labor.
b. the less elastic the supply of labor.
c. the flatter the labor supply curve.
d. the greater the reduction in output caused by a tax on labor.
ANSWER: b.
the less elastic the supply of labor.
71
. The more freedom people are given to choose the date of their retirement
a. the more elastic the supply of labor.
b. the less elastic the supply of labor.
c. the steeper the labor supply curve.
d. the smaller the reduction in output caused by a tax on labor.
ANSWER: a.
the more elastic the supply of labor.
72
. Taxes on labor encourage all of the following EXCEPT

a. older workers to take early retirement from the labor force.
b. mothers to stay at home rather than work in the labor force.
c. workers to work overtime.
d. people to be paid under the table.
ANSWER: c.
workers to work overtime.
73
. Henry George argued that the government should

a. raise all of its revenue from taxes on labor.
b. raise most of its revenue from consumption taxes.
c. raise all of its revenue from a tax on land.
d. raise tax revenue from multiple and diverse taxes.
ANSWER: c.
raise all of its revenue from a tax on land.
74

. Since the amount of land is fixed, the total supply of land is
a. relatively elastic.
b. perfectly elastic.
c. perfectly inelastic.
d. relatively inelastic.
ANSWER: c.
perfectly inelastic.
75
. If the supply of land is fixed, a tax on land would be paid

a. entirely by the landowners.
b. entirely by the renters or users of the land.
c. partly by landowners and partly by land users.
d. only by workers.
ANSWER: a.
entirely by the landowners.
76
. A tax on land
a. would result in a huge deadweight tax loss.
b. would result in no deadweight tax loss.
c. causes resource allocation to not be guided by market forces.
d. would result in none of the above.
ANSWER: b.
would result in no deadweight tax loss.
77
. Todays property tax

a. taxes only the value of land.
b. is exactly the same as Henry Georges single tax proposal.
c. taxes land and the improvements to the land.
d. has no deadweight loss since the amount of revenue going to the government equals the
reduction in the landowners surplus.
ANSWER: c.
taxes land and the improvements to the land.
78
. For Henry Georges single tax on land to not distort economic incentives, the tax would have to be on
the value of
a. improved land.
b. commercial land.
c. unimproved land.
d. urban land.
ANSWER: c.
unimproved land.
79

. According to the famous economist Milton Friedman, the least bad tax is a tax on
a. income received from profits and interest.
b. the value of unimproved land.
c. labor income.
d. the value of land including the improvements to the land.
ANSWER: b.
the value of unimproved land.
80
. As the size of a tax increases

a. the deadweight loss from the tax declines.
b. the deadweight loss from the tax remains constant.
c. the deadweight loss from the tax increases.
d. no one knows how the deadweight loss changes because no tax has ever been reduced.
ANSWER: c.
the deadweight loss from the tax increases.
81
. When the size of a tax is doubled, the deadweight loss from the tax
a. increases by the size of the tax.
b. doubles.
c. remains constant.
d. increases by four times.
ANSWER: d. increases by four times.
82
. The Laffer curve

a. related income tax rates to total income taxes collected.
b. was so ridiculous that economists took it as a joke, hence the name, Laffer Curve.
c. related tax rates to deadweight welfare losses.
d. related government welfare payments to the birth rate.
ANSWER: a.
related income tax rates to total income taxes collected.
83
. Ronald Reagan believed that reducing income tax rates would

a. cause government tax collections to decline.
b. cause government tax collections to rise.
c. cause the Federal deficit (and the national debt) to increase.
d. have no effect on the amount of government tax collections.
ANSWER: b.
cause government tax collections to rise.
84
. One side-effect of the tax cuts made during Ronald Reagans terms as president was
a. increased tax revenues.
b. small budget surpluses.
c. large budget deficits.
d. decreased government spending.
ANSWER: c.
large budget deficits.
85

. Ronald Reagan obviously believed that the labor supply curve was
a. perfectly inelastic.
b. perfectly elastic.
c. relatively inelastic.
d. relatively elastic.
ANSWER: d. relatively elastic.
86
. The views held by Arthur Laffer and Ronald Reagan that cuts in tax rates would encourage people to
increase the quantity of labor they supplied became known as
a. Laffer economics.
b. welfare economics.
c. supply-side economics.
d. microeconomics.
ANSWER: c.
supply-side economics.
87
. During Ronald Reagans first term in office income tax rates were reduced significantly. The result
was that
a. income tax collections declined.
b. income tax collections increased.
c. the Laffer curve was demonstrated to be essentially correct.
d. the government experienced budget surpluses for four consecutive years.
ANSWER: a.
income tax collections declined.
88
. The Laffer curve indicates that income tax collections

a. will be very low if income tax rates are very low.
b. will be very low if income tax rates are very high.
c. will be a maximum amount if income tax rates are at some intermediate level between very low
and very high.
89
. If the government quadrupled the tax on gasoline, the deadweight loss from the gasoline tax would
a. more than quadruple.
b. quadruple.
c. increase, but it would not quadruple.
d. not change.
ANSWER: a.
more than quadruple.
90

. Studies indicate that if income tax rates in Sweden had been reduced, income tax collections would
have
a. fallen.
b. risen.
c. remained constant.
d. risen, fallen, or remained constant (the studies were inconclusive).
ANSWER: b.
risen.
91
. The argument that cutting income tax rates will increase tax revenues
a. clearly has merit for the United States but not for most other countries.
b. clearly has merit for all countries that have income taxes.
c. may not have merit for the United States but has merit for most other countries.
d. is most likely to have merit for any country that has very high marginal tax rates.
ANSWER: d. is most likely to have merit for any country that has very high marginal tax rates.
92
. The higher a countrys tax rates the more likely that country will be
a. on the top of the Laffer curve.
b. on the positively sloped part of the Laffer curve.
c. above the Laffer curve.
d. on the negatively sloped part of the Laffer curve.
ANSWER: d. on the negatively sloped part of the Laffer curve.
93
. In computer games such as Master of Orion, economic growth can best be achieved by
a. brute force.
b. international trade.
c. low taxes.
d. monopoly power.
ANSWER: c.
low taxes.
94
. To win at computer games like SimCity, the best approach would be to employ the philosophy of
a. supply-side economics.
b. welfare economics.
c. Keynesian economics.
d. microeconomics.
ANSWER: a.
supply-side economics.
95

. The underground economy refers to
a. mining and excavation.
b. illegal activities (such as prostitution and illegal drugs).
c. barter and other activities conducted under the table to avoid being taxed.
d. b and c
ANSWER: d. b and c
96
. Tax cuts and deregulation may cause output in an economy to increase by each of the following
EXCEPT
a. increasing the value of output by reducing deadweight tax burdens.
b. luring the underground economy to the surface.
c. increasing incentives to produce.
d. reducing competition.
ANSWER: d. reducing competition.
97
. A major political problem with collecting taxes to finance government spending is that
a. taxes make taxpayers worse off since government spending benefits no one.
b. taxes make taxpayers worse off since government spending benefits only those on welfare.
c. the people who pay the taxes are often not the same people who benefit from the government
spending of tax funds.
d. taxes reduce economic welfare more than the expenditure of tax funds benefits society.
ANSWER: c.
the people who pay the taxes are often not the same people who benefit from the
government spending of tax funds.
98
TRUE/FALSE
.
Normally, both buyers and sellers are worse off when a good is taxed.
ANSWER: T
TYPE: T KEY1: D SECTION: 1 OBJECTIVE: 1 RANDOM: Y
99
Often, the tax revenue collected by the government equals the reduced welfare of buyers and sellers
caused by the tax.
ANSWER: F
100
. A tax places a wedge between the price buyers pay and the price sellers receive.
ANSWER: T
101
. A tax on a good causes the size of the market to increase.

ANSWER: F
102

. A tax raises the price received by sellers and lowers the price paid by buyers.
ANSWER: F
103
When a tax is imposed, the loss of consumer surplus and producer surplus as a result of the tax
exceed the revenue raised by the government.
ANSWER: T
104
The deadweight loss of a tax is the reduction in total surplus in excess of the tax revenue collected
that results from the tax.
ANSWER: T
105
. Taxes create incentives for consumers to buy less and for sellers to sell more.
ANSWER: F
106
.
Because taxes distort incentives, they cause markets to allocate resources inefficiently.
ANSWER: T
107
Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the
gains from trade.
ANSWER: T
108
. The more inelastic the demand and supply curves, the greater the deadweight loss of a tax.
ANSWER: F
109
If the supply curve is more elastic, ceteris paribus, the deadweight loss from a given tax will be
larger.
ANSWER: T
110
If the demand curve is more elastic, ceteris paribus, the deadweight loss from a given tax will be
smaller.
ANSWER: F
111
If a tax did not induce buyers or sellers to change their behavior, it would not cause a deadweight
loss.
ANSWER: T
112

. The most important tax in the U.S. economy is the tax on business profits.
ANSWER: F
113
. The Social Security tax, and to a large extent, the federal income tax, are labor taxes.
ANSWER: T
114
. If all forms of labor taxes are added together, many workers pay a marginal tax rate of almost 80%.
ANSWER: F
115
. Economists disagree on whether labor taxes have a small or a large deadweight loss.
ANSWER: T
116
. If the supply of labor is inelastic, the deadweight loss from labor taxes is large.
ANSWER: F
117
. The underground economy refers to the extractive mining and petroleum industries.
ANSWER: F
118
Labor taxes encourage workers to work fewer hours, second earners to stay at home, the elderly to
retire early, and the unscrupulous to engage in illegal activities.
ANSWER: T
119
In his 1879 book Progress and Poverty, Henry George argued that the government should raise all of
its revenues from a tax on land.
ANSWER: T
120
A tax on unimproved land falls entirely on landowners, because the supply of land is perfectly
inelastic.
ANSWER: T
121
. Because the supply of land is perfectly elastic, the deadweight loss of a tax on land is enormous.
ANSWER: F
122
. A tax on land will distort economic incentives unless the tax applies only to raw (unimproved) land.
ANSWER: T
123

. Milton Friedman believes that the property tax on unimproved land is the least bad tax.
ANSWER: T
124
The demand for bread is less elastic than the demand for donuts; hence, a tax on bread will create a
larger deadweight loss than will the same tax on donuts, ceteris paribus.
ANSWER: F
125
Taxes on necessities will create a smaller deadweight loss than will the same tax on luxuries, ceteris
paribus.
ANSWER: T
126
. The larger the deadweight loss from taxation, the larger the cost of any government program.
ANSWER: T
127
. A tax on insulin is likely to cause a tremendous deadweight loss to society.

ANSWER: F
128
Other things equal, as the size of a tax varies, the deadweight loss from the tax varies according to
the square root of the size of the tax.
ANSWER: F
129
. The deadweight loss of a tax rises even more rapidly than the size of the tax.
ANSWER: T
130
. As the size of a tax increases, the governments tax revenue rises, then falls.
ANSWER: T
131
. If the size of a tax doubles, the deadweight loss rises by a factor of six.
ANSWER: F
132
Although tax revenue eventually begins to fall as tax rates increase, the revenue will always be
greater than zero, no matter how large the tax is.
ANSWER: F
133
Economist Arthur Laffer made the argument that tax rates in the United States were so high,
reducing the rates would increase tax revenue, ceteris paribus.
ANSWER: T
134

. The Laffer curve is the curve showing how tax revenue varies as tax rates vary.
ANSWER: T
135
. Bill Clinton increased the federal income tax rates on high-income taxpayers to about 40%.
ANSWER: T
136
The result of the large tax cuts in the first Reagan Administration demonstrated that Arthur Laffer
was right in his contention that reducing tax rates would increase tax revenues.
ANSWER: F
137
To some extent, the large U.S. federal budget deficits since 1980 can be blamed on the incorrect
assumption by policymakers that the U.S. was on the downward sloping side of the Laffer Curve.
ANSWER: T
138
The view held by Arthur Laffer and Ronald Reagan that tax cuts would raise economic well-being
and perhaps even tax revenues is known as welfare economics.
ANSWER: F
139
. Supply-side economics can be a winning strategy in many computer games.

ANSWER: T
140
In some computer games such as Master of Orion, success can only be achieved through the
imposition of high tax rates to pay for the military costs of world domination.
ANSWER: F
141
The more elastic the supply and demand curves in a market, the more taxes in that market distort
behavior, and the more likely it is that a tax cut will raise tax revenue.
ANSWER: T
142
Taxes are costly to market participants because they transfer resources from those participants to the
government, even though they do not usually distort incentives or resource allocation.
ANSWER: F
143
. According to Oliver Wendell Holmes, taxes are the price we pay for a civilized society.
ANSWER: T
144

.
When the government imposes taxes on buyers and sellers of a good, society loses some of the
benefits of market efficiency.
ANSWER: T
145
SHORT ANSWER
.
What three factors must be taken into account in order to fully understand the effect of taxes on
economic well-being?
ANSWER: In order to assess the impact of taxes on economic well-being, we must compare (1) the effect
on the welfare of buyers and (2) the effect on the welfare of sellers to (3) the amount of revenue the
government raises. The net effect on welfare is measured as the difference between the increased
revenue to the government and the reduced consumer surplus and producer surplus.
TYPE: S KEY1: C OBJECTIVE: 1 RANDOM: Y
146
. What happens to the gains from trade when a tax is imposed? Explain.
ANSWER: A tax causes a reduction in the gains from trade by raising the price the buyer pays and
reducing the price the seller receives. Hence, it will reduce the total volume of trade. This causes a
loss of consumer surplus and producer surplus referred to as deadweight loss. The tax will reduce
the gains realized from some trades and will discourage other trades from being made at all.
TYPE: S KEY1: C SECTION: 1 OBJECTIVE: 1 RANDOM: Y
147
148
Using the graph shown for cases of Coke, calculate each of the following.

a. equilibrium price
b. equilibrium quantity
c. consumer surplus
d. producer surplus
Now suppose that the government imposes a $2.00 tax per case on the sellers of Coke. Show this on the
graph and calculate each of the following after the tax is imposed.
e. price paid by buyers
f. price received by sellers
g. consumer surplus
h. producer surplus
i. government revenue
j. deadweight loss
ANSWER: a.
$6
b. 550
c. $1512.50
d. $1512.50
e. $7
f. $5
g. $1012.50
h. $1012.50
i. $900
j. $100
TYPE: S KEY1: E SECTION: 1 OBJECTIVE: 1 RANDOM: Y

.
Draw a supply-demand diagram for chocolate. On the diagram, show the equilibrium before and
after the imposition of a tax. Now identify areas corresponding to each of the following.
a. consumer surplus before the tax
b. producer surplus before the tax
c. total surplus before the tax
d. consumer surplus after the tax
e. producer surplus after the tax
f. total surplus after the tax
g. tax revenue
h. deadweight loss
ANSWER: A useful way to answer this question is through analysis similar to that shown in Figure 8-3
and Table 8-1 in the text.
TYPE: S KEY1: G SECTION: 1 OBJECTIVE: 1 RANDOM: Y
149
150
Using the graph shown, determine each of the following.
a. equilibrium price before the tax

b. consumer surplus before the tax
c. producer surplus before the tax
d. total surplus before the tax
e. consumer surplus after the tax
f. producer surplus after the tax
g. total tax revenue
h. total surplus (consumer surplus + producer surplus + tax revenue) after the tax
i. deadweight loss

ANSWER: a.
$55
b. $1250
c. $1250
d. $2500
e. $450
f. $450
g. $1200
h. $2100
i. $400
.
Suppose that there are 100 buyers and 100 sellers in a fish market. Because of a tax, each buyer and
seller loses $5 of surplus or benefit. Given this information, what can you say about the total amount
of revenue government collects from the tax.
ANSWER: Because there is a loss of consumer and producer surplus from the tax, there must necessarily
be a deadweight loss associated with the tax, as well. Therefore, we can be certain that the total
revenue collected by the government is less than the amount of lost surplus. Hence, the total tax
revenue must be less than $1,000.
TYPE: S KEY1: E SECTION: 1 OBJECTIVE: 1 INSTRUCTION: 1 RANDOM: Y
151
Craig has been in the habit of mowing Alices lawn each week for $20. Craigs opportunity cost is
$15, and Alice would be willing to pay $25 to have her lawn mowed. What is the maximum tax the
government can impose on lawn mowing without discouraging Craig and Alice from continuing
their mutually beneficial arrangement?
ANSWER: If the tax is less than $10, there will exist a price at which both Craig and Alice will still benefit
from the lawn-mowing arrangement. If the tax is $10, a price can be set which will leave Craig and
Alice neither better-off nor worse-off from the lawn-mowing arrangement. If the tax is greater than
$10, all possible prices will leave at least one of the parties worse-off from the lawn-mowing
arrangement.
152

.
153
Use the graph shown to fill in the following table.
WITHOUT TAX
WITH TAX
CHANGE
WITHOUT TAX
WITH TAX
CHANGE
Consumer surplus
A+B+C
-(B + C)
Producer surplus
D+E+F
-(D + E)
Tax revenue
None
B+D
(B + D)
Total surplus
A+B+C+D+E+F
A+B+D+F
-(C + E)
Consumer surplus
Producer surplus
Tax revenue
Total surplus
ANSWER:

.
154
Suppose that instead of a supply-demand diagram, you are given the following information:
Qs = 100 + 3P
Qd = 400 - 2P
From this information compute equilibrium price and quantity. Now suppose that a tax is placed on
buyers so that
Qd = 400 - (2P + T).
If T = 15, solve for the new equilibrium price and quantity. (Note: P is the price received by sellers and P
+ T is the price paid by buyers.) Compare these answers for equilibrium price and quantity with
your first answers. What does this show you?
ANSWER: Prior to the tax, the equilibrium price would be $60 and the equilibrium quantity would be
280. After the tax is imposed, P, the price received by sellers would be $57. The price paid by
buyers would be $72. The quantity sold would be 271. The new answer shows three obvious facts.
First, buyers pay more with a tax and second, sellers receive less with a tax. The third thing is that
the size of the market shrinks when a tax is imposed on a product.
.
Other things equal, which tax would create the relatively largest deadweight loss, a $50 per acre tax
on unimproved western land, or a $50 per acre tax on western irrigated crop land? What can you say
about the sharing of the burden of the tax in the two situations? Assume that the demand for the
western land and the demand for western irrigated crop land are equally elastic.
ANSWER: Because the supply of unimproved western land is virtually perfectly inelastic, a tax of $50 per
acre would have no effect on the quantity of land supplied. There would be no deadweight loss
associated with the tax, and the burden of the tax would fall entirely on the sellers. The loss of
producer surplus would equal the tax revenue. Because the supply of western irrigated crop land is
not perfectly inelastic, a tax of $50 per acre would reduce the quantity of land supplied, and there
would be a deadweight loss. The burden of the tax would be shared by both buyers and sellers,
depending on the relative elasticities of demand and supply.
155
Economists disagree on the issue of how much labor taxes distort the outcome in labor markets and
create deadweight loss. What characteristics of labor supply is at the heart of the disagreement?
ANSWER: The disagreement among economists about tax distortions in labor markets comes down to
different views about the elasticity of labor supply. If labor supply is fairly inelastic, labor taxes have
a small deadweight loss; if labor supply is quite elastic, labor taxes have a large deadweight loss.
156
In his 1879 book Progress and Poverty, economist Henry George argued that government should
raise all of its revenue from a single tax. What was the tax, and what were the advantages George
expected from the tax?
ANSWER: Henry George advocated a single tax on land, which he believed would be both efficient and
equitable. Deadweight loss would be zero.
157
What is the relationship between elasticities of demand and supply and the size of the deadweight
loss caused by a tax?
ANSWER: The more elastic demand and supply, the greater the deadweight loss from a tax.
158

.
Why do you think that many economists agree that the tax on labor is the most important tax in the
U.S. economy?
ANSWER: Both the Social Security tax and, to a large extent, the federal, state and local income taxes are
labor taxes. If all forms of labor taxes are added together, the marginal tax rate on labor income is
almost 50 percent for many workers.
TYPE: S KEY1: D SECTION: 2 OBJECTIVE: 2 RANDOM: Y
159
160
Using demand and supply diagrams, show the difference in deadweight loss between a market with
inelastic demand and supply curves and a market with elastic demand and supply curves.
ANSWER:

.
Illustrate on three demand and supply graphs how the size of a tax (small, medium and large) can
alter total revenue and deadweight loss.
ANSWER:
161

.
Some economists believe that the deadweight loss of taxes on labor in the U.S. is relatively small,
while other economists believe that the deadweight loss is relatively large. What are the arguments
employed to support these conflicting beliefs?
ANSWER: Economists who believe that the deadweight loss of the tax on labor is small argue that labor
supply is fairly inelastic because most people would work full-time regardless of the wage; hence,
the labor supply curve is almost vertical, and a tax on labor has a small deadweight loss. Economists
who believe that the deadweight loss is large claim that many groups of workers respond to wage
incentives by changing their quantity of labor supplied. These groups include those who work
overtime, second-income earners who can choose to do unpaid work at home or paid work in the
marketplace, elderly people who can choose when to retire and whether to take part-time work after
retirement, and people who engage in illegal economic activity in the underground economy.
162

.
Henry George argued that a single tax on land would be both equitable and efficient. Under what
conditions would a tax on land be efficient, i.e., create no deadweight loss for society?
ANSWER: If the tax were on the unimproved value of land, it would create no deadweight loss, since the
supply of land is perfectly inelastic. However, if the tax were on the value of improvements as well,
landowners would have less incentive to make improvements, and the quantity of improved land
would decline, reducing the size of the market and creating deadweight loss.
163
Draw a Laffer curve. On which part of the Laffer curve does the U.S. economy operate? Are there
individuals in the U.S. operating on the other side of the curve? What evidence can you cite to
justify your answers?
ANSWER: The curve should look similar to panel (b) of Figure 8-7 in the text. The U.S. is apparently
operating on the upward-sloping part of the Laffer curve, based on the results of the reduction in
personal income tax rates in 1980. From 1980 to 1984, real income per person increased by 4 percent,
but real income tax revenue per person fell by 9 percent. However, tax revenue collected from the
richest Americans, who faced the highest tax rates, did increase when their taxes were cut,
indicating that they were on the downward-sloping part of the Laffer curve.
164
What is the relationship between a change in the size of a tax, and the change in the deadweight loss
from the tax?
ANSWER: The deadweight loss increases more than proportionately to the increase in the tax.
Specifically, the deadweight loss increases proportionately to the square of the increase in the tax.
For example, if the tax doubles, the deadweight loss quadruples. If the tax increases by a factor of 3,
the deadweight loss increases by a factor of 9.
165
. According to the Laffer curve, what will happen to tax revenue if tax rates are reduced?
ANSWER: It depends on how high tax rates are to begin with. If tax rates are relatively low, and the
economy is on the upward-sloping part of the Laffer curve, a tax reduction will lower tax revenue.
However, if tax rates are relatively high, and the economy is on the downward-sloping part of the
Laffer curve, a tax reduction will increase tax revenue.
166
Ronald Reagan cut taxes sharply in 1980. Between 1980 and 1984, income per person in the U.S.
grew by 4 percent. What happened to revenue from personal income taxes during that period?
What does that imply about the position of the U.S. economy on the Laffer curve?
ANSWER: Between 1980 and 1984, personal income tax revenue per person fell by 9 percent. Hence, the
U.S. must have been on the upward-sloping part of the Laffer curve.
167
What is the best predictor of whether reducing a tax in a market will increase or decrease tax
revenue?
ANSWER: The best predictor is the elasticity of supply and the elasticity of demand in the market. The
more elastic supply and demand are in a market, the more taxes in that market distort behavior, and
the more likely it is that a tax cut will raise tax revenue.
168

.
Suppose that a tax is imposed on the coal market, and is left in place for several years. What would
you predict about (a) the size of the deadweight loss of the tax in the short run relative to the long
run, and (b) the amount of revenue collected from the tax in the short run relative to the long run?
Assume that the economy doesnt grow during the period in question.
ANSWER: Because both demand and supply tend to be more elastic in the long run than in the short run,
we would predict that (a) the deadweight loss of the tax would be larger in the long run than in the
short run, and (b) the tax revenue would be smaller in the long run than in the short run.
169
ANSWER: c. British taxes imposed on the American Colonies.

2
ANSWER: d. reduced Federal income tax rates.

3
ANSWER: b. income tax rates fell.

4
ANSWER: c. both price and quantity of the good sold will change.
5
ANSWER: a. raises the price buyers pay and lowers the price sellers receive.
6
ANSWER: b. consumer and producer surplus

7
ANSWER: a. the supply curve upward or to the left.

8
ANSWER: d. the demand curve downward or to the left.

9
ANSWER: a. both buyers and sellers are economically worse off.

10
ANSWER: b. B.
11
ANSWER: c. C.
12
ANSWER: b.
B + C.
13
ANSWER: c. the supply curve shifts left (up) by an amount equal to the tax.
TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 RANDOM: Y
14
ANSWER: a. buyers and sellers share the burden of the tax regardless of which it is levied on.
15
ANSWER: c. causes the size of the market for the good to shrink.
16
ANSWER: c. a wedge is placed between the price buyers pay and the price sellers receive.
17
ANSWER: a. consumer surplus.

18
ANSWER: b. tax revenue.

19
ANSWER: b. producer surplus.

20
ANSWER: a. the benefit received by those people who gain from governments expenditure of the tax
revenue.
21
ANSWER: a. P1.
RANDOM: Y
22
ANSWER: c. P3.
RANDOM: Y
23
ANSWER: b. P2.
RANDOM: Y
24
ANSWER: b. A + B + C.
25
ANSWER: c. D + E + F.
26
ANSWER: a. A.
RANDOM: Y
27
ANSWER: d. F.
RANDOM: Y
28
ANSWER: b. B + C.
RANDOM: Y
29
ANSWER: c. D + E.
RANDOM: Y
30
ANSWER: b. B + D.
31
ANSWER: c. A + B + D + F.
RANDOM: Y
32
ANSWER: d. C + E.
RANDOM: Y
33
ANSWER: c. deadweight loss.

34
ANSWER: a. the reduction in total surplus that results from a tax.

35
ANSWER: b. $12.
RANDOM: Y
36
ANSWER: a. $16.
RANDOM: Y
37
ANSWER: c. $8.
RANDOM: Y
38
ANSWER: b. $125.
39
ANSWER: b. $125.
40
ANSWER: d.
$45.
RANDOM: Y
41
ANSWER: d. $45.
RANDOM: Y
42
ANSWER: b. $80.
RANDOM: Y
43
ANSWER: b. $80.
RANDOM: Y
44
ANSWER: b. $120.
45
ANSWER: c. $250.
46
ANSWER: d. $210.
RANDOM: Y
47
ANSWER: c. $40.
48
RANDOM: Y
ANSWER: d. $ 20.
49
ANSWER: d. $10.
50
ANSWER: a. Joe will now clean his own home.

51

52

53

54
ANSWER: c. Don will gain $10 per week.

55
ANSWER: c. Phil will gain $10 per week.

56
ANSWER: b. $20 per week.

57
ANSWER: b. is higher when tax rates are higher than when tax rates are lower.
58
ANSWER: a. the price elasticity of demand and supply.

59
ANSWER: c. the greater the deadweight loss of a tax.

60
ANSWER: c. a relatively large change in the amounts sellers are willing to sell.
61
ANSWER: a. more.
62
ANSWER: b. relatively large.

63
ANSWER: c. relatively small.

TYPE: M KEY1: D SECTION: 2 OBJECTIVE: 2 INSTRUCTION: 4 RANDOM: N
64
ANSWER: b. change less

65
ANSWER: a. relatively large.

TYPE: M KEY1: D SECTION: 2 OBJECTIVE: 2 INSTRUCTION: 5 RANDOM: Y
66
ANSWER: b. less.
67
ANSWER: c. labor.
68
ANSWER: a. earnings from labor.

69

70
ANSWER: c. 50%.
71
ANSWER: b. the less elastic the supply of labor.

72
ANSWER: a. the more elastic the supply of labor.

73
ANSWER: c. workers to work overtime.

74
ANSWER: c. raise all of its revenue from a tax on land.

75
ANSWER: c. perfectly inelastic.

76
ANSWER: a. entirely by the landowners.

77
ANSWER: b. would result in no deadweight tax loss.

78
ANSWER: c. taxes land and the improvements to the land.

79
ANSWER: c. unimproved land.

80
ANSWER: b. the value of unimproved land.

81
ANSWER: c. the deadweight loss from the tax increases.

82
ANSWER: d. increases by four times.

83
ANSWER: a. related income tax rates to total income taxes collected.

84
ANSWER: b. cause government tax collections to rise.

85
ANSWER: c. large budget deficits.

86
ANSWER: d. relatively elastic.

87
ANSWER: c. supply-side economics.

88
ANSWER: a. income tax collections declined.

89

90
ANSWER: a. more than quadruple.

91
ANSWER: b. risen.
92
ANSWER: d. is most likely to have merit for any country that has very high marginal tax rates.
93
ANSWER: d. on the negatively sloped part of the Laffer curve.

94
ANSWER: c. low taxes.

95
ANSWER: a. supply-side economics.

96
ANSWER: d. b and c
97
ANSWER: d. reducing competition.

98
ANSWER: c. the people who pay the taxes are often not the same people who benefit from the
government spending of tax funds.
99
ANSWER: T
100
ANSWER: F
101
ANSWER: T
102
ANSWER: F
103
ANSWER: F
104
ANSWER: T
105
ANSWER: T
106
ANSWER: F
107
ANSWER: T
108
ANSWER: T
109
ANSWER: F
110
ANSWER: T
111
ANSWER: F
112
ANSWER: T

113
ANSWER: F
114
ANSWER: T
115
ANSWER: F
116
ANSWER: T
117
ANSWER: F
118
ANSWER: F
119
ANSWER: T
120
ANSWER: T
121
ANSWER: T
122
ANSWER: F
123
ANSWER: T
124
ANSWER: T
125
ANSWER: F
126
ANSWER: T
127
ANSWER: T
128
ANSWER: F

129
ANSWER: F
130
ANSWER: T
131
ANSWER: T
132
ANSWER: F
133
ANSWER: F
134
ANSWER: T
135
ANSWER: T
136
ANSWER: T
137
ANSWER: F
138
ANSWER: T
139
ANSWER: F
140
ANSWER: T
141
ANSWER: F
142
ANSWER: T
143
ANSWER: F
144
ANSWER: T

145
ANSWER: T
146
ANSWER: In order to assess the impact of taxes on economic well-being, we must compare (1) the effect
on the welfare of buyers and (2) the effect on the welfare of sellers to (3) the amount of revenue the
government raises. The net effect on welfare is measured as the difference between the increased
revenue to the government and the reduced consumer surplus and producer surplus.
TYPE: S KEY1: C OBJECTIVE: 1 RANDOM: Y
147
ANSWER: A tax causes a reduction in the gains from trade by raising the price the buyer pays and
reducing the price the seller receives. Hence, it will reduce the total volume of trade. This causes a loss
of consumer surplus and producer surplus referred to as deadweight loss. The tax will reduce the gains
realized from some trades and will discourage other trades from being made at all.
148
ANSWER:
a.
b.
c.
d.
$6
550
$1512.50
$1512.50
[Insert figure 8-9 here for answer 148.]

e.
$7
f.
$5
g.
$1012.50
h.
$1012.50
i.
$900
j.
$100
149
ANSWER:
A useful way to answer this question is through analysis similar to that shown in Figure 8-3 and Table 8-1 in the
text.
150
ANSWER:
a.
$55
b.
$1250
c.
$1250
d.
$2500
e.
$450
f.
$450
g.
$1200
h.
$2100
i.
$400
151
ANSWER: Because there is a loss of consumer and producer surplus from the tax, there must
necessarily be a deadweight loss associated with the tax, as well. Therefore, we can be certain that the
total revenue collected by the government is less than the amount of lost surplus. Hence, the total tax
revenue must be less than $1,000.
TYPE: S KEY1: E SECTION: 1 OBJECTIVE: 1 INSTRUCTION: 1 RANDOM: Y
152
ANSWER: If the tax is less than $10, there will exist a price at which both Craig and Alice will still
benefit from the lawn-mowing arrangement. If the tax is $10, a price can be set which will leave Craig
and Alice neither better-off nor worse-off from the lawn-mowing arrangement. If the tax is greater than
$10, all possible prices will leave at least one of the parties worse-off from the lawn-mowing
arrangement.
153
ANSWER:
Consumer surplus
Producer surplus
WITHOUT TAX
WITH TAX
CHANGE
A+B+C
A
-(B + C)
D+E+F
F
Tax revenue
Total surplus
-(D + E)
None
B+D
(B + D)
A+B+C+D+E+F
A+B+D+F
-(C + E)
154
ANSWER:
Prior to the tax, the equilibrium price would be $60 and the equilibrium quantity would be 280. After the tax is
imposed, P, the price received by sellers would be $57. The price paid by buyers would be $72. The quantity
sold would be 271. The new answer shows three obvious facts. First, buyers pay more with a tax and second,
sellers receive less with a tax. The third thing is that the size of the market shrinks when a tax is imposed on a
product.
155
ANSWER: Because the supply of unimproved western land is virtually perfectly inelastic, a tax of $50
per acre would have no effect on the quantity of land supplied. There would be no deadweight loss
associated with the tax, and the burden of the tax would fall entirely on the sellers. The loss of producer
surplus would equal the tax revenue. Because the supply of western irrigated crop land is not perfectly
inelastic, a tax of $50 per acre would reduce the quantity of land supplied, and there would be a
deadweight loss. The burden of the tax would be shared by both buyers and sellers, depending on the
relative elasticities of demand and supply.
156
ANSWER: The disagreement among economists about tax distortions in labor markets comes down to
different views about the elasticity of labor supply. If labor supply is fairly inelastic, labor taxes have a
small deadweight loss; if labor supply is quite elastic, labor taxes have a large deadweight loss.
157
ANSWER: Henry George advocated a single tax on land, which he believed would be both efficient and
equitable. Deadweight loss would be zero.
158
ANSWER: The more elastic demand and supply, the greater the deadweight loss from a tax.
159
ANSWER: Both the Social Security tax and, to a large extent, the federal, state and local income taxes are
labor taxes. If all forms of labor taxes are added together, the marginal tax rate on labor income is almost
50 percent for many workers.
TYPE: S KEY1: D SECTION: 2 OBJECTIVE: 2 RANDOM: Y
160
ANSWER:
161
ANSWER:
162
ANSWER: Economists who believe that the deadweight loss of the tax on labor is small argue that labor
supply is fairly inelastic because most people would work full-time regardless of the wage; hence, the
labor supply curve is almost vertical, and a tax on labor has a small deadweight loss. Economists who
believe that the deadweight loss is large claim that many groups of workers respond to wage incentives
by changing their quantity of labor supplied. These groups include those who work overtime, secondincome earners who can choose to do unpaid work at home or paid work in the marketplace, elderly
people who can choose when to retire and whether to take part-time work after retirement, and people
who engage in illegal economic activity in the underground economy.
163
ANSWER: If the tax were on the unimproved value of land, it would create no deadweight loss, since
the supply of land is perfectly inelastic. However, if the tax were on the value of improvements as well,
landowners would have less incentive to make improvements, and the quantity of improved land would
decline, reducing the size of the market and creating deadweight loss.
164
ANSWER: The curve should look similar to panel (b) of Figure 8-7 in the text. The U.S. is apparently
operating on the upward-sloping part of the Laffer Curve, based on the results of the reduction in
personal income tax rates in 1980. From 1980 to 1984, real income per person increased by 4 percent, but
real income tax revenue per person fell by 9 percent. However, tax revenue collected from the richest
Americans, who faced the highest tax rates, did increase when their taxes were cut, indicating that they
were on the downward-sloping part of the Laffer Curve.
165
ANSWER: The deadweight loss increases more than proportionately to the increase in the tax.
Specifically, the deadweight loss increases proportionately to the square of the increase in the tax. For
example, if the tax doubles, the deadweight loss quadruples. If the tax increases by a factor of 3, the
deadweight loss increases by a factor of 9.
166
ANSWER: It depends on how high tax rates are to begin with. If tax rates are relatively low, and the
economy is on the upward-sloping part of the Laffer Curve, a tax reduction will lower tax revenue.
However, if tax rates are relatively high, and the economy is on the downward-sloping part of the Laffer
Curve, a tax reduction will increase tax revenue.
167
ANSWER: Between 1980 and 1984, personal income tax revenue per person fell by 9 percent. Hence, the
U.S. must have been on the upward-sloping part of the Laffer Curve.
168
ANSWER: The best predictor is the elasticity of supply and the elasticity of demand in the market. The
more elastic supply and demand are in a market, the more taxes in that market distort behavior, and the
more likely it is that a tax cut will raise tax revenue.
169
ANSWER: Because both demand and supply tend to be more elastic in the long run than in the short
run, we would predict that (a) the deadweight loss of the tax would be larger in the long run than in the
short run, and (b) the tax revenue would be smaller in the long run than in the short run.

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Chapter 8

Application: The Costs of Taxation

In 1776, the American Revolution was sparked by anger over

During Ronald Reagans eight years in office

When a tax is levied on a good

2Chapter 8/Application: The Costs of Taxation

A tax levied on the supplier of a product shifts

A tax levied on the buyers of a product shifts

When a tax is levied on a good

Chapter 8/Application: The Costs of Taxation3

. According to the graph, total economic surplus would be represented by area

TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 GRAPH FORMAT: M

4Chapter 8/Application: The Costs of Taxation

. When a tax on a good is enacted,

. A tax placed on a good

. When a tax is levied on a good

. The benefit received by buyers in a market is measured by

Chapter 8/Application: The Costs of Taxation5

. The benefit received by the sellers of a good in a market is measured by

. The benefit from a tax is measured by

6Chapter 8/Application: The Costs of Taxation

Chapter 8/Application: The Costs of Taxation7

8Chapter 8/Application: The Costs of Taxation

Chapter 8/Application: The Costs of Taxation9

10Chapter 8/Application: The Costs of Taxation

. According to the graph, producer surplus before the tax equaled

Chapter 8/Application: The Costs of Taxation11

12Chapter 8/Application: The Costs of Taxation

. Taxes may cause deadweight losses because

Chapter 8/Application: The Costs of Taxation13

. The total gain in welfare due to the transaction described here is

. The deadweight economic loss from taxes

. The amount of deadweight loss from taxes depends on

14Chapter 8/Application: The Costs of Taxation

. If the supply of a good is relatively elastic, changing the price causes

. A tax levied on gasoline will cause the loss of consumer surplus to be

Chapter 8/Application: The Costs of Taxation15

. A tax levied on entertainment will cause the loss of producer surplus to be

. The social security tax is, primarily, a tax on

16Chapter 8/Application: The Costs of Taxation

. Taxes on labor encourage all of the following EXCEPT

. Henry George argued that the government should

Chapter 8/Application: The Costs of Taxation17

. If the supply of land is fixed, a tax on land would be paid

. Todays property tax

18Chapter 8/Application: The Costs of Taxation

. As the size of a tax increases

. The Laffer curve

. Ronald Reagan believed that reducing income tax rates would

Chapter 8/Application: The Costs of Taxation19

. The Laffer curve indicates that income tax collections

20Chapter 8/Application: The Costs of Taxation

Chapter 8/Application: The Costs of Taxation21

. A tax on a good causes the size of the market to increase.

22Chapter 8/Application: The Costs of Taxation

Chapter 8/Application: The Costs of Taxation23

24Chapter 8/Application: The Costs of Taxation

. A tax on insulin is likely to cause a tremendous deadweight loss to society.

Chapter 8/Application: The Costs of Taxation25

. Supply-side economics can be a winning strategy in many computer games.

26Chapter 8/Application: The Costs of Taxation

Chapter 8/Application: The Costs of Taxation27

28Chapter 8/Application: The Costs of Taxation