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)$4, and the deadweight loss comes from both Luke and Leia.
B)$4, and the deadweight loss comes only from Luke because he does not buy gelato after the tax.
C)$2, and the deadweight loss comes from both Luke and Leia.
D)$2, and the deadweight loss comes only from Luke because he does not buy gelato after the tax.

Question

Quizplus · Accepted Answer

Deadweight loss is the reduction in economic efficiency resulting from a market distortion like a tax. In this case, the fat tax of $3 increases the price of a scoop of gelato from $2 to $5, making it too expensive for Luke to buy, as he values it at $4. Therefore, he does not buy gelato after the tax, resulting in a deadweight loss of $2 ($4 - $2, his initial valuation minus the post-tax price). Leia still buys gelato even after the tax, as she values it at $6, so there is no deadweight loss from her. Hence, the deadweight loss comes only from Luke, and the answer is D.

Suppose Luke Values a Scoop of Italian Gelato at $4