Potato market tax

This activity is appropriate for a micro principles course and for an early AE in an intermediate micro course. Students should have knowledge of welfare analysis in the S-D market framework.
The preferred method of reporting is the gallery walk. If classroom does not allow a gallery walk, the exercise will need to be modified before use. This activity will require 30-45 minutes of class time.
This activity is based on the same initial circumstance as that in the Potato Market Cartel AE but the two AEs are independent of one another.

Overview

This application exercise bolsters students' understanding of the analysis of a tax in the S-D market analytical framework. (Note that the analytical technique used is identifying the single market quantity sold that is consistent with a $3.50 tax. This technique has the advantages of being easier for students than shifting the D or S curve AND, more importantly, emphasizing that the economic incidence of a sales tax -- i.e. one collected from buyers -- and of an excise tax -- i.e. one collected from sellers -- is independent of the legal incidence.)
Students are also asked to consider the question of whether the existence of DWL should lead to the conclusion that the tax should be abolished. This question leads to a useful debriefing conversation to articulate the reasoning that should guide sound thinking about taxes and government spending.

Expected Student Learning Outcomes

Upon successful completion of this learning activity, students should be able to analyze the effect of a sales or excise tax on market quantity and price, the effect on consumer surplus, producer surplus, and government revenue, and the incidence of the tax. Students should also be able to explain that a tax that creates DWL can be welfare-enhancing if the associated government spending yields more additional total surplus than the DWL of the tax. Students should also be able to describe additional criteria for evaluating the effect of any particular tax, including the cost of administering the tax and the existence of an alternative tax that results in less DWL.

Information Given to Students

Consider the US market for wholesale potatoes in which potatoes are sold in 100-lb. sacks.
Suppose that the competitive market outcome features a market-clearing price of $6 per sack.
Suppose the federal government -- in an effort to reduce carbohydrates in the American diet, perhaps -- imposes a tax of $3.50 per sack of potatoes. Add the graphical analysis of the tax and resulting changes in gains from trade to the handout.
There is deadweight loss. Should the tax therefore be abolished?
Gallery walk reporting.

Potato Market Tax AE Handout (Microsoft Word 2007 (.docx) 108kB Feb12 18)
Potato Market Tax AE Answer Key (Microsoft Word 2007 (.docx) 399kB Feb12 18)

One might remind students of how to analyze a tax before the exercise.
In the debriefing, there are two very likely errors that student teams will make. First, many teams will predict a rise in the price of a sack of potatoes of the full $3.50 and a fall in market quantity sold to below 350 million sacks per year. Make sure to get the team reporters who got it right to identify and correct the error of a team reporter that has explained why their team predicts the $3.50 rise in price.
The second common mistake will occur in the tabulation of the welfare analysis. Make sure to walk students through the correct welfare analysis as part of the summary comments. (Alternatively, have the student reporters who have it correct explain the errors in one or several other team reports. This takes more class time but would likely be valuable for student learning.)

This problem lends itself easily to becoming a question on a summative individual assessment.