Suppose Luke values a scoop of Italian gelato at $4. Leia values a scoop of Italian gelato at $6. The pre-tax price of a scoop of Italian gelato is $2. The government imposes a "fat tax" of $3 on each scoop of Italian gelato, and the price rises to $5. The deadweight loss from the tax is
A)$1.
B)$2.
C)$3.
D)$4.

Question

Quizplus · Accepted Answer

The deadweight loss from a tax is the loss of consumer and producer surplus caused by the tax. In this case, the tax is $3, so Luke's willingness to pay for a scoop of gelato ($4) is now less than the price ($5) and he chooses not to buy it. Similarly, Leia's willingness to pay ($6) is now reduced to $5, and she buys it but at a lower quantity than before. This difference in quantity between what consumers would have bought without the tax and what they actually buy with the tax is the deadweight loss.

Without the tax, Luke and Leia would have bought 1 and 2 scoops of gelato respectively, for a total value of $16. With the tax, Leia buys 1 scoop and Luke buys 0, for a total value of $5. The deadweight loss is therefore $11, which is greater than the tax revenue of $3.

Therefore, the best choice is B, as it is closest to the deadweight loss of $11.

Suppose Luke Values a Scoop of Italian Gelato at $4