S. Klepper, Economics 73-100, Fall 2009

Solution to Mini-test 5

If the tax is doubled, then the marginal cost of each hotel room will rise by $10. Since the tax is imposed on hotels and not consumers, the demand curve for hotels will be unchanged. The effects of the doubling of the tax are pictured in the figure below. The market supply curve shifts up at every level of output by $10, reflecting the rise in marginal cost of $10 at every level of output. This causes the market supply curve to shift to the left. In turn, this causes the quantity of hotel rooms occupied to decline and the price of hotel rooms to rise. As indicated in the figure, the price rises in the short run by less than $10. With price rising and quantity falling, it is not possible to predict the effect of the tax increase on total expenditures without knowing the price elasticity of demand. As for the tax revenue collected by the city, with quantity falling the total tax revenue collected by the city of Pittsburgh will not go up by 100%.

Based on this description, the answers to the individual questions are:

_____1. True

_____2. True

_____3. False—not necessarily

_____4. True

_____5. False