1.      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. (25 points)

1.1     What is the statutory incidence of this tax? (5)

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. (10)

1.3     When would the economic incidence of CPP premiums be 100% on employees? Illustrate with a diagram. (10)

2        A California legislative committee has voted to legalize marijuana, sell it through state liquor stores, and impose a $50 per ounce tax on it, as a way of solving the state’s budget deficit problems.  A study by the Rand Corporation reports that the street (retail) price of marijuana in California is $75 to $100 per ounce; however legalization is expected to reduce production costs. (50 points)

      If marijuana was legal, the commercial supply of marijuana in California would be given by:  P^s=25+Q^s or Q^s=P^s-25, where Q is the quantity supplied in millions of ounces, and P is the price per ounce.

       The demand for marijuana in California is given by:  P^d=150-4Q^d or Q^d=37.5-0.25P^d

2.1  Graph the before tax supply and demand for marijuana, and work out the equilibrium price and quantity. (10)

2.2  Suppose a $50 per ounce tax on marijuana is implemented. Using the fact that P^d=P^s+tax, substitute for P^d in the demand curve. Draw the after-tax demand curve in terms of P^s on your diagram from part (2.1). (5)

2.3  Work out the after-tax quantity and prices. What is the economic incidence of a marijuana tax? How much revenue does it raise? (10)

2.4  Redraw your diagram from part (2.1). Using the fact that P^s=P^d-tax, substitute for P^s in the supply curve. Draw the after-tax supply curve in terms of P^d on your diagram. Confirm that this gives you the same results as the method used in parts (2.2) and (2.3). (10)

2.5  Marijuana – unlike alcohol or tobacco or gasoline – is a low maintenance plant that can easily be grown in one’s backyard or a kitchen window. Suppose that, if marijuana is legalized, the marginal cost of home-grown marijuana (of equivalent quality to store-purchased) is constant at $55 per ounce.  How does the existence of an untaxed, home-grown supply of marijuana change your analysis in part (2.4)? What happens to prices, quantities, and government revenue? Use a diagram to work out your answer. (15)

3        Jason spends all of his income on two goods: soda and pizza. The government introduces a new ‘soda tax’ that taxes sodas. (25 points)

3.1     Show the effect of a tax on soda on Jason’s budget constraint and optimal choice. (5)

3.2     Draw on your diagram the revenue raised by the tax on soda. (5)

3.3     What would Jason’s budget constraint look like if the government imposed a lump-sum tax that raised the same revenue as the tax on soda? (5)

3.4     Using your diagram/analysis and the definition of Pareto efficiency, explain why the tax on soda is not Pareto efficient. (10)