Question: Suppose that the government increases retail sales taxes on students' purchases of selected items in the university bookstore. Government analysts project a $1 million increase in sales tax revenue that will fund a reduction in student tuition, and a marginal welfare loss of $200,000.
a. What is the marginal welfare cost of the tax increase, per dollar of additional tax revenue?
b. What is the minimum return that the government must make on its investment in the university to ensure that national welfare does not decline?
c. How do you think the marginal welfare cost per dollar might change if the government increases the sales tax on a good for which student demand is relatively price inelastic, such as food? What if the government increases the sales tax on a good for which demand is relatively price sensitive, such as novelty items with the school logo?
d. Assume a preexisting production subsidy in the industry that supplies the university bookstore with taxed items, such as textbooks. In a short paragraph, explain the possible second-best effect of the new tax.