Department of Economics
University of Wisconsin-La Crosse
ECON110 Principles of Economics
Homework 4 Due November 11th 2008
1. Number 10, Chapter 8, page 175. This chapter analyzed the welfare effects of a tax on a good.
Consider now the opposite policy. Suppose that the government subsidizes a good: For each
unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect
consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to
deadweight loss? Explain.
2. Number 11, Chapter 8, page 175. Hotel rooms in Smalltown go for $100, and 1,000 rooms
are rented on a typical day.
a. To raise revenue, the mayor decides to charge hotels a tax of $10 per rented room. After
the tax is imposed, the going rate for hotel rooms rises to $108, and the number of
rooms rented falls to 900. Calculate the amount of the revenue this tax raises for
Smalltown and the deadweight loss of the tax.
b. The mayor now doubles the tax to $20. The price rises to $116, and the number of rooms
rented falls to 8090. Calculate tax revenue and deadweight loss with this larger tax. Do
they double, more than double, or less than double? Explain.
3. Number 8, Chapter 9, page 198: The nation of Textilia does not allow imports of clothing. In
its equilibrium without trade, a T-shirt costs $20, and the equilibrium quantity is 3 million t-
shirts. One day, after reading Adam Smith’s The Wealth of Nations while on vacation, the
president decides to open the Textilian market to international trade. The market price of a
t-shirt falls to the world price of $16. The number of t-shirts consumed in Textilia rises to 4
million, while the number of t-shirts produced declines to 1 million.
a. Illustrate the situation just described in a graph. Your graph should show all the
b. Calculate the change in consumer surplus, producer surplus, and total surplus that
results from opening up trade.
4. Number 9, Chapter 9, page 198. Consider a country that imports a good from abroad. For
each of the following statements, say whether it is true or false. Explain your answer.
a. “The greater the elasticity of demand, the greater the gains from trade.”
b. “If demand is inelastic, there are no gains from trade.”
c. “If demand is inelastic, consumers do not benefit from trade.”
5. Number 11, Chapter 12, page 263. Use the data in Table 8 to answer these questions about
the U.S. tax system:
a. For each quintile, compute the federal taxes paid by the typical taxpayer.
b. As a taxpayer moves from each quintile to the next higher quintle, compute the
change in income and the change in taxes.
c. Use the information in part b to compute the marginal tax rate as a person moves
from one quintile to the next.
d. For any given taxpayer, which is higher—the marginal tax rate or the average tax
e. What happens to the average tax rate and the marginal tax rate as income rises?
Which changes more?
me rises ?
Which changes more?