Question: In an effort to reduce alcohol consumption, the government is considering a $1 tax on each gallon of liquor sold (the tax is levied on producer). Suppose that the supply curve for liquor is upward sloping and its equation is Q s 30,000P (where Q is the number of gallons of liquor and P is the price per gallon). The demand curve for liquor is Q = 500,000 - 20,000P.
a. Draw a sketch to illustrate the excess burden of the tax. Next use algebra to calculate the excess burden. Show graphically the excess burden generated by the $1 unit tax.
b. Suppose that each gallon of liquor consumed generates a negative external cost of $0.50. How does this affect the excess burden associated with the unit tax on liquor?