The market for pizza is characterized by a downward-sloping demand curve and an upward- sloping supply curve. a. Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and producer surplus. Is there any deadweight loss? Explain. b. Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold. Illustrate the effect of this tax on the pizza market, being sure to label the consumer surplus, producer surplus, government revenue, and deadweight loss. How does each area compare to the pre-tax case? c. If the tax were removed, pizza eaters and sellers would be better off, but the government would lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their gains to the government. Could all parties (including the government) be better off than they were with a tax? Explain using the labeled areas in your graph. a. Figure 3 illustrates the market for pizza. The equilibrium price is P 1 , the equilibrium quantity is Q 1 , consumer surplus is area A + B + C, and producer surplus is area D + E + F. There is no deadweight loss, as all the potential gains from trade are realized; total surplus is the entire area between the demand and supply curves: A + B + C + D + E + F.
Figure 3 b. With a $1 tax on each pizza sold, the price paid by buyers, P B , is now higher than the price received by sellers, P S , where P B = P S + $1. The quantity declines to Q 2 , consumer surplus is area A, producer surplus is area F, government revenue is area B + D, and deadweight loss is area C + E. Consumer surplus declines by B + C, producer surplus declines by D + E, government revenue increases by B + D, and deadweight loss increases by C + E. c. If the tax were removed and consumers and producers voluntarily transferred B + D to the government to make up for the lost tax revenue, then everyone would be better off than without the tax. The equilibrium quantity would be Q 1 , as in the case without the tax, and the equilibrium price would be P 1 . Consumer surplus would be A + C, because consumers get surplus of A + B + C, then voluntarily transfer B to the government. Producer surplus would be E + F, because producers get surplus of D + E + F, then voluntarily transfer D to the government. Both consumers and producers are better off than the case when the tax was imposed. If consumers and producers gave a little bit more than B + D to the government, then all three parties, including the government, would be better off. This illustrates the inefficiency of taxation. Suppose that the government imposes a tax on heating oil. Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain. Would the revenue collected from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain.
a. The deadweight loss from a tax on heating oil is likely to be greater in the fifth year after it is imposed rather than the first year. In the first year, the elasticity of demand is fairly low, as people who own oil heaters are not likely to get rid of them right away. But over time they may switch to