1. In February 2003, Senator Don Perata of California proposed a tax on the manufacturers of disposable diapers.

"In California, we face staggering population growth that will only add to our already overtaxed landfills," said Perata, D-Oakland. "Elected officials, policy makers, health professionals, waste haulers, recycling experts and parents agree, disposable diapers just don't belong in our state's landfills, for both environmental and public health reasons."

The proposed bill would place a tax on each diaper sold. Sen. Perata has affirmed that the tax will be on manufacturers rather than on the already over-taxed residents of California. The goal of the policy is to raise $60 million to pay for local recycling programs in California.

As a member of board of the Alameda Taxpayers Association, you have been asked to evaluate the proposal using supply and demand analysis.

a. Draw a simple graph showing the equilibrium in the disposable diaper market before any policy action. Explain why this is an equilibrium.

b. Add to this diagram the proposed tax on paper diapers and explain what will happen to the equilibrium price and quantity. (Hints: Usually, taxes can be represented by a shift of the supply curve or the demand curve. Note that only one curve shifts, and only shift the curve for the party which faces the legal incidence The shift represents the amount of the tax, and quantity falls after the tax.)

c. Illustrate on your diagram how much revenue will be raised by the paper diaper tax.

d. Who will bear the burden of this tax? Show this on the diagram. And discuss the factors affecting who will bear more of the burden of this fee.

e. What will determine the amount of reduction in the use of paper diapers caused by the tax on paper diapers?

2. Suppose that the demand for cigarettes is given by QD=2000–200P. The supply of cigarettes is QS=800P. (Hints: I discussed the specific calculation steps in the lecture notes.)

a) Find the price and quantity of cigarettes, assuming that the market is competitive.

b) In an effort to reduce smoking, the government levies a tax of $1 per pack. Compute the quantity of cigarettes after the tax, the price paid by consumers, and the price paid by producers. How much revenue does the government gain from the tax? (Reminder: don’t forget to solve the equations for P before graphing and please assume that the legal tax incidence is imposed on producers here!)

c) Who bears the bigger economic burden – consumers or producers? Why? Would you expect this to be the case in real life? Why or why not?

d) Calculate the deadweight loss of the tax.

3. In order to encourage more housing consumption among low-income families the federal government decides to provide a per-unit subsidy to firms that build low-income housing. Demonstrate the effect that this program will have on the housing market

a. Draw a graph showing the initial market equilibrium.

b. Add to this diagram the proposed subsidy and explain what will happen to the equilibrium price and quantity.

c.   Identify on your graph the amount of government expenditure and the distribution of the program benefits between producers and consumers.

d. What determines who receives the larger benefit from the program, consumers or producers? Explain.

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Taxes & Subsidies

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