Econ of pa

School of Public Affairs and Administration, Rutgers University-Newark
541: Economics for Public Administration
Professor Pengju Zhang
Problem Set 3
Taxes & Subsidies
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.
Draw a simple graph showing the equilibrium in the disposable diaper market
before any policy action. Explain why this is an equilibrium.
a.
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.)
b.
c. Illustrate on your diagram how much revenue will be raised by the paper diaper tax.
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.
d.
What will determine the amount of reduction in the use of paper diapers caused by
the tax on paper diapers?
e.
2. Suppose that the demand for cigarettes is given by QD=2000–200P. The supply of
cigarettes is QS=800P. (Hints: I discussed specific calculation steps in my 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 on
producers. 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 set the equations for P
before graphing, as the vertical axis in your diagram is P, not Q.)
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.