Suppose that the market for large,64-ounce soft drinks in the town of Pudgyville is characterized by a typical,downward-sloping,linear demand curve and a typical,upward-sloping,linear supply curve.The market is initially in equilibrium with 1,000 soft drinks sold per day.The newly-elected Mayor of Pudgyville wants to tax 64-ounce soft drinks.She is considering either a $0.10 tax or a $0.30 tax.Her chief economic advisor estimates that the number of soft drinks sold after a $0.10 tax will be 900 and after a $0.30 tax will be 500.Which tax is better?
A)The $0.10 tax is better because it raises more revenue and creates a lower deadweight loss than the $0.30 tax.
B)The $0.30 tax is better because it raises more revenue and creates a lower deadweight loss than the $0.10 tax.
C)It is not clear which tax is better because although the $0.30 tax raises more tax revenues,it creates a larger deadweight loss than the $0.10 tax.
D)It is not clear which tax is better because although the $0.10 tax raises more tax revenues,it creates a larger deadweight loss than the $0.30 tax.

Question

Quizplus · Accepted Answer

Both taxes will increase the price of 64-ounce soft drinks and reduce the quantity demanded. However, the $0.30 tax will have a larger effect on reducing quantity demanded than the $0.10 tax. As a result, the $0.30 tax will create a larger deadweight loss, which represents a loss of consumer and producer surplus due to the inefficiency of the tax. Although the $0.30 tax raises more tax revenue, this is not enough to offset the larger deadweight loss. Therefore, the $0.10 tax is a better choice because it creates a lower deadweight loss than the $0.30 tax, even though it raises less tax revenue.

Suppose That the Market for Large,64-Ounce Soft Drinks in the Town