Discussion:
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 Cudi's consumption of guitars and marijuana for each year using an indifference curve diagram. Carefully label all important points.
b. What is Kid Cudi's equivalent variation?
c. What is the deadweight loss from taxing Kid Cudi's marijuana consumption?