b. “A tax that raises no revenue for the government cannot have any deadweight loss.” The statement, "A tax that raises no revenue for the government cannot have any deadweight loss," is incorrect. An example is the case of a 100% tax imposed on sellers. With a 100% tax on their sales of the good, sellers will not supply any of the good, so the tax will raise no revenue. Yet the tax has a large deadweight loss, because it reduces the quantity sold to zero 6. A subsidy is the opposite of a tax. With a $0.50 tax on the buyers of ice-cream cones, the government collects $0.50 for each cone purchased; with a $0.50 subsidy for the buyers of ice- cream cones, the government pays buyers $0.50 for each cone purchased. a. Show the effect of a $0.50 per cone subsidy on the demand curve for ice-cream cones, the effective price paid by consumers, the effective price received by sellers, and the quantity of cones sold.
The effect of a $0.50 per cone subsidy is to shift the demand curve up by $0.50 at each quantity, because at each quantity a consumer's willingness to pay is $0.50 higher. The effects of such a subsidy are shown in Figure 12. Before the subsidy, the price is P 1 . After the subsidy, the price received by sellers is P S and the effective price paid by consumers is P D , which equals P S minus $0.50. Before the subsidy, the quantity of cones sold is Q 1 ; after the subsidy the quantity increases to Q 2 . b. Do consumers gain or lose from this policy? Do producers gain or lose? Does the government gain or lose? Because of the subsidy, consumers are better off, because they consume more at a lower price. Producers are also better off, because they sell more at a higher price. The government loses, because it has to pay for the subsidy. 7. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain. The figure and table below illustrate the effects of the $2 subsidy on a good. Without the subsidy, the equilibrium price is P 1 and the equilibrium quantity is Q 1 . With the subsidy, buyers pay price P B , producers receive price P S (where P S = P B + $2), and the quantity sold is Q 2 . The following table illustrates the effect of the subsidy on consumer surplus, producer surplus, government revenue, and total surplus. Because total surplus declines by area D + H, the subsidy leads to a deadweight loss in that amount. OLD NEW CHANGE Consumer Surplus A + B A + B + E + F + G +(E + F + G) Producer Surplus E + I B + C + E + I +(B + C) Government Revenue 0 –(B + C + D + E + F + G + H) –(B + C + D + E + F + G + H) Total Surplus A + B + E + I A + B – D + E – H + I –(D + H)
8. Consider how health insurance affects the quantity of healthcare services performed. Suppose that the typical medical procedure has a cost of $100, yet a person with health insurance pays only $20 out of pocket. Her insurance company pays the remaining $80. (The insurance company recoups the $80 through premiums, but the premium a person pays does not depend on how many procedures that person chooses to undertake.)