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Unformatted text preview: 8-18TAXES AND WELFAREPurpose: To show the effects of an excise tax on social welfare.Computer file: taxwelf98.xlsInstructions and background information:In the previous problem set you showed that competitive markets ordinarily maximize thewelfare from a good or service. The reason markets have this remarkable and desirablecharacteristic is that in the market equilibrium the sum of consumer and producer surplus is aslarge as possible.A corollary to this result is that interference with the operation of a free market, if itchanges price and quantity, must reduce welfare as measured by the sum of producer andconsumer surplus. In this problem set you will explore the effects of an excise tax on welfare in amarket for pizza. The result is that the tax causes welfare to decrease, even taking into accountthe gain in revenue the government gets from the tax. This decrease in welfare is usually referredto a the deadweight lossdue to the tax.The deadweight loss due to an excise tax is a form of economic inefficiency. Its areduction in consumer and producer surplus, and the result is that less than the socially bestamount of the good is produced, and it is sold at too high a price. Another way economistsdescribe this result is to say that excise taxes distort the allocation of resources. This is justanother way of saying that when the excise tax is imposed, too little of societys resources will be...
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- Spring '08
- Excise Taxes