The Pullman Company has a lot of pull in the town of Pullman, Illinois. Everybody in town is identical, and they all work for the company, which pays them each $10 a day. The company runs the government, pocketing all tax revenue for itself. Residents eat apples, which they purchase from a mail order company for $1 apiece. But the company imposes a 100% sales tax, so residents actually pay $2 apiece for apples.
a. Draw the typical resident's budget line between "apples" and "all other goods" (measured in dollars). Draw in the optimum point. Label the corresponding quantity of apples A.
b. Use your graph to illustrate the amount of revenue that Pullman derives from the apple tax. (Hint: How much income do you have left after buying A apples? How much income would you have left if you had bought the same number of apples at the untaxed price of $1 apiece? Where is the difference going?
c. Pullman wants to lower the wage rate to $8 a day. Unfortunately, if residents become any less happy, they will all leave town. However, Pullman has calculated that eliminating the apple tax would be just enough to convince people to stay in town at a wage of $8 a day. Assuming that Pullman lowers the wage and eliminates the tax, draw the new budget
line.
d. True or False: The combined changes described in part (c) leave Pullman neither better nor worse off than before.