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Business Finance : Public Economics, Taxation


Kid Cudi lives in Colorado, where he spends his money on two
goods, marijuana and guitars. Both are normal goods. In 2013, he
earned $100,000, marijuana costs $100/ounce, and guitars cost $1000
a piece. That year, he purchased 900 ounces of marijuana and 10
guitars. In 2014, prices remained the same, he earned $150,000, and
purchased 1200 ounces of marijuana and 30 guitars. In 2015, the
Colorado legislature, in need of revenue, enacted a 66.6% ad
valorem sales tax on marijuana purchases, the most rapidly growing
part of the state economy. Not only will Kid Cudi have to face this
tax, but his earnings will remain at $150,000. He will purchase 40
guitars and spend the remainder of his earnings on marijuana, but
be no better off than in 2013.
a. Graphically show Kid Cudis consumption of
guitars and marijuana for each year using an indifference curve
diagram. Carefully label all important points.
b. What is Kid Cudis equivalent variation?
c. What is the deadweight loss from taxing Kid Cudis
marijuana consumption?

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