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Unformatted text preview: PADP 6950: Founda1ons of Policy Analysis Demand PRACTICE Angela Fer1g, PhD Market Demand Experiment 1 Market Demand Experiment Discussion Which group had highest price elas1city of demand for Reese's cups? Which group had the lowest elas1city? What does this difference in elas1city say about the people in these 2 groups? Market Demand Experiment Discussion 2 Were these complements or subs1tutes (or neither) to Reese's cups: Soda? M&Ms? Apples? 2 Policy Exercise: Sin Tax A "sin" tax is an excise tax on a par1cular good (not income) with the aim of reducing consump1on of that good because it has nega1ve outcomes: Alcohol tax, cigareXe tax "snack" tax, soda tax Carbon tax The revenue from a sin tax is oYen used to address these nega1ve outcomes (smoking cessa1on programs, etc.) Exercise Let's figure out from scratch what the effect of a sin tax is on tax revenue and consump1on for 2 different situa1ons: 1. When the price elas1city of demand is high (people are very responsive to price) 2. When the price elas1city of demand is low (people are insensi1ve to price) 3 Step 1a: Choices without tax Price = 15 Budget line: 1000 = 15S + 20G U1lity func1on: U = S*G where U = 833.33 1. Draw out both lines on the same graph 2. Find the op1mal bundle without the tax 4 Step 1b: Choices without tax Price = 10 Budget line: 1000 = 10S + 20G U1lity func1on: U = S*G where U = 1250 1. Draw out both lines on the same graph 2. Find the op1mal bundle without the tax 5 Step 1c: Choices without tax Price = 5 Budget line: 1000 = 5S + 20G U1lity func1on: U = S*G where U = 2500 1. Draw out both lines on the same graph 2. Find the op1mal bundle without the tax 6 Step 2: Choice Demand Use these 3 prices to draw out a demand curve for cigareXes. 7 Step 3: Introduce tax A tax of $5 is levied for each unit of S. 1. On a separate graph, draw the budget lines where P=5, 10, and 15, but the quan11es that are affordable must take into account the $5 tax 2. Add on the highest indifference curves for each budget line (U(5)=1250, U(10)=833.3, U(15)=625) 3. Find the new op1mal bundles with the tax 4. Use these 3 prices w/ tax to draw out the demand curve with the tax 8 Note From now on, you won't use the consumer choice model to see what happens to the demand curve. You will just know that if a tax is put on a good, the demand curve shiYs down by the tax amount. Tax Policy and Elas1city P S Delas1c Dinelas1c Dinelas1c w/tax Qe Qi Qo Delas1c w/tax CigareXes 9 Ques1ons When the policy goal is to reduce smoking, what kind of elas1city would a policy advisor want to see before recommending a tax? When the policy goal is raising tax revenue to fund ini1a1ves, what kind of elas1city would a policy advisor want to see before recommending a tax? 10 ...
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- Spring '11