For Each $100 An Employee Earns, The Employer Pays $445
1for Each 100 That An Employee Earns The Employer Pays 445 In Can
For each $100 that an employee earns, the employer pays $4.45 in Canada Pension Plan premiums and the employee pays $4.45 in Canada Pension Plan premiums.
1.1 What is the statutory incidence of this tax?
The statutory incidence of the CPP premiums is on both the employee and the employer equally, with each paying $4.45 per $100 of wages. This means, legally, the responsibility to pay is split evenly between the employee and the employer, with each bearing the burden explicitly as mandated by law.
1.2 Draw a diagram illustrating a situation where the economic incidence of the tax and the statutory incidence of the tax are the same. Explain clearly in words and using your diagram what economic incidence means.
In a situation where the economic incidence matches the statutory incidence, the burden of the tax falls exactly on the parties legally designated to pay it. For example, if the law states both parties pay $4.45 each, and market conditions do not allow the burden to shift, then both statutory and economic incidences are the same.
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Economic incidence refers to the actual distribution of the tax burden among market participants, regardless of legal assignment. It depends on the relative elasticities of supply and demand. When demand is perfectly inelastic or supply is perfectly inelastic, the economic incidence falls entirely on one side. If demand is more inelastic than supply, consumers bear more of the tax burden in practice, even if statutory incidence suggests an even split.
In this scenario, since both parties pay equal amounts and market conditions do not facilitate shifting the burden, the economic and statutory incidences are aligned.
1.3 When would the economic incidence of CPP premiums be 100% on employees? Illustrate with a diagram.
The economic incidence would be fully on employees if the supply of labor is perfectly inelastic—that is, employees cannot change the quantity of labor they supply, regardless of the premium. In this case, employers would bear the entire cost, but because the law requires employees to pay, the cost effectively falls on them.
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In such a scenario, even if the law mandates employer contributions, the actual economic burden is borne solely by employees because they cannot adjust their labor supply in response to the premium; they pay the full amount, illustrating 100% incidence on employees.
2. Marijuana Legalization and Taxation in California
California's decision to legalize marijuana and impose a $50 per ounce excise tax introduces complex supply and demand dynamics that can be analyzed using economic models. The initial supply and demand curves before tax establish the market equilibrium, which shifts when a tax is introduced, affecting prices, quantities, and government revenue.
2.1 Graph the before-tax supply and demand for marijuana, and work out the equilibrium price and quantity.
The supply curve is given by: Qs = Ps - 25, and the demand curve by: Qd = 37.5 - 0.25 Pd.
At equilibrium, supply equals demand:
Qs = Qd
Ps - 25 = Pd with Pd = Ps.
Substituting Pd with Ps in demand: Qd = 37.5 - 0.25 Ps.
Set Qs = Qd: Ps - 25 = 37.5 - 0.25 Ps
Solving for Ps: Ps - 25 + 0.25 Ps = 37.5
1.25 Ps = 62.5
Ps = 50
Then, substitute into supply or demand to get quantity:
Qs = 50 - 25 = 25 million ounces
Thus, equilibrium price is $50 per ounce, and equilibrium quantity is 25 million ounces.
2.2 Implementing a $50 per ounce tax
Given the demand function Pd = 150 - 4Qd, and noting that with a $50 tax, Pd = Ps + 50, we substitute into the demand curve:
Pd = 150 - 4Qd = Ps + 50
Rearranged as: Ps = Pd - 50
Expressed in terms of Ps: Pd = Ps + 50.
Substitute into the demand equation:
Pd = 150 - 4Qd
Replace Pd with Ps + 50:
Ps + 50 = 150 - 4Qd
Express Qd:
Qd = (150 - Ps - 50) / 4 = (100 - Ps) / 4
The supply curve remains Qs = Ps - 25.
2.3 Calculate after-tax equilibrium quantities and prices; interpret economic incidence and revenue
Set Qs = Qd: Ps - 25 = (100 - Ps) / 4.
Multiply both sides by 4:
4 Ps - 100 = 100 - Ps
Bring all to one side:
4 Ps + Ps = 100 + 100
5 Ps = 200
Ps = 40
Now, compute Qd: Qd = (100 - 40)/4 = 15 million ounces.
Determine Pd: Pd = Ps + 50 = 40 + 50 = 90.
Thus, after-tax price paid by consumers is $90, and the net price received by suppliers is $40. The economic incidence falls mostly on consumers, who pay a higher price, confirming that consumers bear the majority of the tax burden. The government revenue: 50 * 15 = $750 million.
2.4 Effect of home-grown marijuana with a marginal cost of $55
The availability of untaxed, home-grown marijuana at a constant marginal cost of $55 per ounce alters the market dynamics. Since this cost is above the government’s $50 tax rate, home growers can supply marijuana more cheaply than taxed store-bought sources at prices below $55, which discourages legal sales at the taxed price. The result is a decrease in legal market quantities, a reduction in government revenue, and potential black-market proliferation.
Using diagrammatic analysis, the supply curve from home growers is horizontal at $55, reflecting perfect competition among home growers. Since this supply is cheaper than the taxed legal supply, consumers prefer to buy home-grown, cheaper marijuana, reducing the legal market volume and shifting equilibrium quantities downward. Prices would stay at or near $55 to encourage legal sellers to participate, but many consumers would opt for home-grown marijuana, thus decreasing government revenue significantly, possibly approaching zero if the entire market shifts underground.
3. Impact of Soda Tax on Consumer Behavior and Efficiency
Jason’s consumption bundle involves soda and pizza. The introduction of a beverage tax raises the per-unit price of soda, affecting his budget constraint and choice set. Additionally, analyzing the tax’s efficiency involves understanding how it influences welfare compared to alternative revenue mechanisms.
3.1 Effect of soda tax on Jason's budget constraint and optimal choice
The original budget constraint is:
Ps Qs + Pp Qp = Income.
After a soda tax t per unit, the price of soda rises to Ps + t, which tilts the budget line inward, reducing feasible combinations of soda and pizza. The new budget line intersects the axes at lower quantities, and Jason’s optimal choice shifts to a new point on the indifference curve tangent to the new constraint, typically reducing soda consumption.
3.2 Draw the revenue raised by the soda tax
The revenue is calculated as the tax rate multiplied by the quantity of soda sold post-tax: Revenue = t * Qs, after.
3.3 Budget constraint with lump-sum tax of same revenue
A lump-sum tax reduces overall income by an amount equal to the revenue generated by the soda tax. This shifts the entire budget line inward parallel to the original, decreasing consumption possibilities equally across all goods, but no longer preferentially targeting soda.
3.4 Why the soda tax is not Pareto efficient
A Pareto efficient allocation is achieved when no one can be made better off without making someone else worse off. The soda tax introduces deadweight loss because it distorts consumption choices—reducing overall welfare without compensation—leading to inefficiency. It reallocates resources and reduces total surplus, as some mutually beneficial exchanges are forgone due to the higher soda price.
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