Leonard, Sheldon, Raj, and Penny each like science fiction moves. The price of a special boxed set of Star Trek DVDs is $50. Leonard values the set of movies at $70, Sheldon at $65, Raj at $60, and Penny at $55. Suppose that if the government taxes DVDs at $10 each, the price rises to $60. A consequence of the tax is that consumer surplus shrinks by
A)$50 and tax revenues increase by $30, so there is a deadweight loss of $20.
B)$35 and tax revenues increase by $30, so there is a deadweight loss of $5.
C)$20 and tax revenues increase by $20, so there is no deadweight loss.
D)$15 and tax revenues increase by $20, so there is no deadweight loss.

Question

Quizplus · Accepted Answer

Before the tax, the total value that the four friends placed on the DVDs was $250 ($70+$65+$60+$55). They were willing to pay $200 in total ($50 each), meaning they generated $50 of consumer surplus ($250 minus $200).

After the tax, the price of the DVDs rises to $60, and each person must pay $10 in tax ($60 minus $50). Leonard now only gains $10 of consumer surplus ($70 minus $60), Sheldon gains $5 ($65 minus $60), Raj gains $0 ($60 minus $60), and Penny loses $5 ($55 minus $60). The total value generated is now only $180 ($10+$5+$0-$5 x 4), and each person pays $60, meaning there is now $20 of deadweight loss ($180 minus $200).

Tax revenues increase by $30 (four people paying a $10 tax), which is exactly offset by the $30 reduction in consumer surplus. Therefore, the net effect is that consumer surplus shrinks by $35 ($50 original consumer surplus minus $15 final consumer surplus), and deadweight loss is $5.

Leonard, Sheldon, Raj, and Penny Each Like Science Fiction Moves