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16 March, 17:04

Assume the price of gasoline is $2.00 per gallon, and the equilibrium quantity of gasoline is 10 million gallons per day with no tax on gasoline. Starting from this initial situation, which of the following scenarios would result in the largest deadweight loss?

a. The price elasticity of demand for gasoline is 0.1; the price elasticity of supply for gasoline is 0.6; and the gasoline tax amounts to $0.20 per gallon.

b. The price elasticity of demand for gasoline is 0.1; the price elasticity of supply for gasoline is 0.4; and the gasoline tax amounts to S0.20 per gallon.

c. The price elasticity of demand for gasoline is 0.2; the price elasticity of supply for gasoline is 0.6; and the gasoline tax amounts to $0.30 per gallon.

d. There is insufficient information to make this determination.

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Answers (1)
  1. 16 March, 17:31
    0
    The correct answer is option c.

    Explanation:

    Deadweight loss is the loss of surplus due to the imposition of a tax which is not offset by government. The deadweight loss is higher when the elasticity of demand and supply is higher and the tax rate is higher as well.

    When the elasticity of demand and supply is high, the tax wedge created by the imposition of the tax would cause the equilibrium quantity to decline to a greater extent. As a result, the deadweight loss will be higher as well.

    In the given example, the elasticity of demand and supply, and the tax amount is highest in case of option c. This means that the deadweight loss will be highest in the case of option c.
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