You are a consultant to the government of Buttony. The government has decided to
ID: 1118724 • Letter: Y
Question
You are a consultant to the government of Buttony. The government has decided to cut taxes on one of the following: apples, bananas, or cantaloupe. The government wants your input on which fruit would be the best choice for a tax cut. It provides you with the following information. What is your recommendation and why?
Good Unit Price Sales (thousands) Unit Tax Marginal Tax Revenue (Thousands of dollars per $1 additional tax) Marginal Deadweight Loss (thousands of dollars per $1 additional tax) Apples $1 100 $0.10 20 5 Bananas $2 100 $0.25 30 20 Cantaloupe $4 50 0.15 10 20Explanation / Answer
Answer.) First we need to check the burden of Marginal Deadweight Loss on Marginal Tax Revenue .
we find that for apples its, 5/20 which is 0.25
for Bananas its, 20/30 which is 0.666 and
for Cantaloupe its, 20 / 10 which is 2
Ideally, Taxes should be set so that the marginal deadweight burden per marginal dollar of revenue generated is equal across goods. But as the results presented above indicating, Buttony is nowhere around this benchmark situation its so because taxes imposed in most inefficient way in Buttony in previous period. As we analysed, The marginal deadweight burden per marginal dollar of revenue is much higher for cantaloupe than for the other goods. Therefore, Cutting taxes on cantaloupe would be the most efficient: for a given revenue reduction, cutting cantaloupe taxes would reduce the deadweight loss the most.
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