Question

Every summer, Matt travels by air to see his grandmother. Matt’s willingness to pay for an airline ticket is $260, but the airline only requires a minimum of $100 to fly him. Normally, Matt pays the airline the going market price of $250 per ticket. Suppose that Matt and the airline are the only consumer and producer in this market. If the government places a $50 tax on each ticket, raising ticket prices to $270, and causing Matt not to go, what is the deadweight loss created by this tax?

Answer 1

The deadweight loss created by a $50 tax on an airline ticket, which raises the price to $270 and results in no purchase by Matt, is equal to the consumer surplus of $10 that Matt would have gained from buying the ticket at the market price without the tax.

Step-by-step explanation:

The student is asking about the concept of deadweight loss in the context of taxation and market prices. Specifically, they are seeking to understand the deadweight loss resulting from a $50 tax on an airline ticket that raises the price above Matt's willingness to pay, causing him to no longer purchase the ticket.

To calculate the deadweight loss, we need to consider the difference between the price the consumer is willing to pay and the price after tax. Before the tax, Matt is willing to pay $260 for a ticket, and he actually pays $250, which is the market price. With a $50 tax, the price jumps to $270, which is above Matt's willingness to pay. Because Matt decides not to purchase the ticket at this new price, there is a loss of economic efficiency.

In terms of the consumer surplus and producer surplus, the deadweight loss refers to the loss of these surpluses that occurs when market transactions are not made due to the tax. In this case, because Matt is not buying the ticket at all, the consumer surplus that he would have experienced (the difference between his willingness to pay and the market price, which is $260 - $250 = $10) is completely lost. Additionally, the producer surplus—the difference between the minimum price the producer is willing to accept ($100) and the market price ($250)—is also lost as there is no sale. Thus, the deadweight loss is the total of these lost surpluses.

It is important to note that in a more complex market with more consumers and producers, the deadweight loss would be represented by the area of the triangle formed between the supply and demand curves and the quantity bought and sold before and after the tax is introduced. However, in this simplified scenario with a single consumer and producer, we can say that the deadweight loss is equal to the entire consumer surplus ($10) that Matt would have gained if he had purchased the ticket at the market price without the tax.