Answer
a) 4 bottles will be consumed, and each person has a consumer surplus of 8 dollars.
b) The new surplus is 4 dollars per person.
c) Cindy's welfare increases to 4.50 dollars, and total surplus increases in Whoville.
d) Consumption falls to 3 bottles, so the consumer surplus increases to 4.50 per person. Government revenue is 3 dollars per person. There are no external costs, and total surplus per person is 7.50 dollars.
e) I would support the mayor's policy.
Work Step by Step
a)
First bottle surplus: $5-1.5=3.5$
Second bottle surplus: $4-1.5=2.5$
Third bottle surplus: $3-1.5=1.5$
Fourth bottle surplus: $2-1.5=.5$
$3.5+2.5+1.5+.5=8$
b) 4 bottles consumed incur an external cost of 4 dollars (1 dollar per bottle). Total surplus less the external cost is the new surplus, so $8-4=4$.
c) Consumption decreases to three bottles.
$5+4+3=12$
$12-3*2.50$
$12-7.50$
$4.5$
d) The tax increases the cost to 2.50 per bottle, so consumption falls to 3 bottles (since the fourth bottle has a willingness of 2 dollars). The tax revenue is $3*1=3$ dollars. There are no external costs since everyone is consuming their efficient levels of Zlurp. The total surplus is the same as consumer surplus and tax revenue.
$4.5+3=7.5$
e) Consumer surplus increases, and the government gains tax revenue.
