The question
Name: ______________________ Date: ____________ A per-unit tax on ferry rides: prices, revenue, incidence and deadweight loss, then a subsidy and its cost (10 points)
The market for ferry rides to Kesh, an invented island, is competitive: many ferry companies and many riders, each too small to set the price. Demand and supply are straight lines, and the market is in equilibrium at a price of $5 a ride with 50 rides a day. The government places a per-unit tax of $2 on each ride, collected from the ferry companies.
(A) Draw a correctly labeled graph of the market for ferry rides and show the effect of the tax on the market price paid by riders and the quantity of rides. [3 points]
(B) Shade the area that represents the government's tax revenue. [1 point]
(C) After the tax, riders pay $6 a ride, ferry companies keep $4 a ride, and 40 rides a day are taken. Calculate each of the following. Show your work. (i) The government's daily tax revenue. (ii) The deadweight loss of the tax. [2 points]
(D) Suppose instead that riders' demand for ferry rides is more inelastic than the supply of rides. Identify whether riders or ferry companies would bear the larger share of the tax, and explain. [1 point]
(E) Mira splits her weekly travel budget between ferry rides and bus rides and was maximizing her utility before the tax, when a ferry ride cost $5. Explain, using marginal utility per dollar, why she takes fewer ferry rides once the price rises to $6. [1 point]
(F(i)) Now suppose the government removes the tax and instead pays ferry companies a subsidy of $2 for each ride. Riders then pay $4, companies receive $6, and 60 rides a day are taken. Calculate the cost of the subsidy to the government. Show your work. [1 point]
(F(ii)) Shade the area that represents the cost of the subsidy to the government. [1 point]