Experiment 4 An excise tax in the apple market

4.1 Introduction

CORE projects

Concepts in the experiment are related to the material in:

An excise tax is a per-unit tax imposed on a particular good or service. What are the efficiency effects of taxation when used to raise revenue? How should tax revenue be returned? Who ultimately pays the tax? Does it matter who collects the tax?

This experiment presents a competitive market where students act either as suppliers or demanders of apples. The experiment consists of three scenarios that share the same distribution of suppliers and demanders:

  1. an apple market with no government interference, representing a simple trading-pit experiment,
  2. the same apple market with a per-unit tax paid by sellers, and
  3. the same apple market with a per-unit tax paid by buyers rather than sellers.

The experiment can be used for three different purposes.

  • Running Scenario 1 alone can provide students with the experience of a competitive market and show them how demand and supply meet in setting the equilibrium price and quantity. They can draw step demand and supply functions (see, for example, Exercise 8.3 in The Economy), compute surplus, and compare the theoretical predictions with the experimental outcomes. It also helps students understand the concept of market equilibrium.
  • Running Scenarios 1 and 2 is likely to be the most common use of the experiment. In addition to the previous points, it gives students an insight into the functioning of a tax. They can experience the excess burden of the tax and discuss the use of the tax revenue. They can easily work on shifting the supply curve and can compute tax incidence and the deadweight loss. (See the ‘Discussion’ section for other possible applications.)
  • Running all three scenarios adds to the analysis by allowing for discussion about whom to impose the tax on.

This experiment is based on ‘A Tax in the Apple Market’ from Experiments with Economic Principles by Ted Bergstrom, Marcus Giamattei, Humberto Llavador, and John Miller. You can find additional material there.

Key concepts

This experiment will help students understand the following key concepts:

  • Supply and demand curves
  • Market equilibrium
  • Shifting supply and demand curves
  • Excise tax or per-unit tax
  • Tax burden
  • Tax incidence
  • Deadweight loss

4.2 Requirements

Timing

The experiment is flexible and allows for different formats. You can conduct Scenario 1 (a simple trading-pit experiment) in 15 minutes. Conducting scenarios 1 and 2 (simple trading plus a sales tax) will take 40 minutes, including a brief discussion. All three scenarios, with discussion, can be easily run within a 50-minute class, especially if students have already participated in other experiments with a market. If you want to conduct all three scenarios and allow for a full discussion, or if this is the first experiment your students participate in, an 80-minute class may be more appropriate. You can speed it up by giving students access to the instructions beforehand. Running the experiment online will make the transaction process faster, but students will lose the experience of interacting with each other when trading, and it will take longer to converge to equilibrium.

4.3 Description of the experiment

In this experiment, students act either as suppliers or as demanders of a single good, bushels of apples. Each supplier can sell and each demander can buy either 0 or 1 bushel of apples. A supplier’s Seller Cost (SC) for a bushel of apples is assigned automatically to each seller by the game and is visible in each seller’s personal information screen. A demander’s Buyer Value (BV) is similarly assigned. The distribution of Buyer Values and Seller Costs stays constant throughout the experiment.

4.4 Step-by-step guide

Detailed instructions

Go to the ‘Quick summary’ section if you have previously run the experiment and just need a brief reminder of the instructions.

The experiment contains three scenarios, but it is flexible and can be cut short to attain different goals. If you want to show the functioning of a market equilibrium, use Scenario 1 (a market without taxes). If you want to study the effect of a sales tax and tax incidence, run Scenario 1 and Scenario 2 (tax on sellers). Finally, to show the neutrality of tax collection, add Scenario 3 (tax on buyers).

4.5 Student instructions

These are also available in the students’ version.

A PDF of the student instructions and homework questions is also available.

Introduction

There is a hint of frost in the air and the leaves are changing colour. You regularly go to the Farmers’ Apple Market to buy and sell bushels of apples. One day, the local authority decides to collect a tax of €15 for each bushel of apples sold.

Instructions (for all scenarios)

In this experiment, you will try to make profits by buying or selling (imaginary) bushels of apples. In each market scenario, you will be assigned a role, either as a supplier who can sell one bushel of apples or as a demander who can buy one bushel of apples (Figure A).

Your objective is to make as much profit as possible. Profit will be measured in ‘currency units’, that we will denote with a currency sign (€, £, or $; we will use € in these instructions).

Screenshots of a supplier and a demander for online trading. Screens are the same for in-class trading, except that demanders do not have the ‘Buy’ button and are assigned an ID number (see Figure B).
Screenshots of a supplier and a demander for online trading. Screens are the same for in-class trading, except that demanders do not have the ‘Buy’ button and are assigned an ID number (see Figure B).

Figure A Screenshots of a supplier and a demander for online trading. Screens are the same for in-class trading, except that demanders do not have the ‘Buy’ button and are assigned an ID number (see Figure B).

Supplier.
: Supplier.

Supplier.

Figure A-a

Demander.
: Demander.

Demander.

Figure A-b

If you are a supplier, you will be assigned a Seller Cost (the cost of growing a bushel of apples) and you can sell at most one bushel of apples per round. If you sell a bushel of apples for a price , and your Seller Cost is , then your profit from the transaction is the difference, . If , you are better off not selling and taking zero profits rather than selling for a loss.

If you are a demander, you will be assigned a Buyer Value (your willingness to pay for a bushel of apples). You can buy at most one bushel of apples per round. If your Buyer Value is , and you buy one bushel of apples for a price , your profit from the transaction will be , that is, the difference between how much you value the bushel of apples and how much you paid for it. If you have to pay more than your Buyer Value, you are better off not buying any apples and taking zero profits rather than doing it for a loss.

At the beginning of the experiment, your instructor will announce whether you are using online or offline trading.

Offline trading

In offline trading, sellers and buyers must find each other and agree on a price. If they reach an agreement, the seller should type the price and the buyer’s ID into her screen and select the ‘Sell’ button. The buyer must accept the offer to finalize the contract (Figure B).

Offline trading: Once a buyer and a seller have reached a verbal agreement, they can formalize the transaction on their devices.
Offline trading: Once a buyer and a seller have reached a verbal agreement, they can formalize the transaction on their devices.
Offline trading: Once a buyer and a seller have reached a verbal agreement, they can formalize the transaction on their devices.

Figure B Offline trading: Once a buyer and a seller have reached a verbal agreement, they can formalize the transaction on their devices.

Selling
: The seller types the agreed price  and the buyer’s ID (5) on her screen and selects the ‘Sell’ button.

Selling

The seller types the agreed price and the buyer’s ID (5) on her screen and selects the ‘Sell’ button.

Buying
: The buyer must accept the offer to finalize the transaction. Before it is complete, both the seller and the buyer can cancel the transaction by withdrawing or rejecting the offer, respectively.

Buying

The buyer must accept the offer to finalize the transaction. Before it is complete, both the seller and the buyer can cancel the transaction by withdrawing or rejecting the offer, respectively.

The transaction
: Once the buyer has accepted the transaction, the bushel of apples moves from the seller to the buyer. They cannot do anything else until the next round, since at most one unit can be bought or sold in each round.

The transaction

Once the buyer has accepted the transaction, the bushel of apples moves from the seller to the buyer. They cannot do anything else until the next round, since at most one unit can be bought or sold in each round.

The sales contract is then publicly displayed on the instructor’s screen (Figure C).

Completed transactions appear in the instructor’s screen, showing the Buyer Values (), the Seller Costs (), and the prices ().

Figure C Completed transactions appear in the instructor’s screen, showing the Buyer Values (), the Seller Costs (), and the prices ().

It is a good idea to think in advance about what you will do the first time you are in the market and negotiating with other students. There are many strategies you could use and there is not a single right answer. But remember to shop around and look at the prices that have already been posted on the instructor’s screen.

Online trading

In the online market, sellers can send a selling price that demanders will see in the contracts section of their screens (Figure D). Similarly, buyers can send a buying price that suppliers will see in the contracts section of their screens. Whether you are a supplier or a demander, your offer (if you made one) and all standing offers you can accept are shown in the contracts section of your screen. You can withdraw your offer and make a new one only if it has not been accepted yet. You can accept an offer by selecting the ‘Accept’ button. Note that once you accept an offer or your offer gets accepted, all other offers are automatically rejected, as you can only trade one bushel of apples.

Example of a seller’s and a buyer’s screen for online trading.
Example of a seller’s and a buyer’s screen for online trading.

Figure D Example of a seller’s and a buyer’s screen for online trading.

Selling
: A seller has sent a selling offer (marked as ‘OWN’) and has received one buying offer. She can withdraw the offer, as no buyer has accepted it yet.

Selling

A seller has sent a selling offer (marked as ‘OWN’) and has received one buying offer. She can withdraw the offer, as no buyer has accepted it yet.

Buying
: A buyer has received three selling offers and must decide whether to accept any of them or none. He has not made his buying offer yet.

Buying

A buyer has received three selling offers and must decide whether to accept any of them or none. He has not made his buying offer yet.

When a buyer accepts a selling offer or a seller accepts a buying offer, the transaction takes place and is displayed on the instructor’s screen. Since only one unit can be traded in each round, the buyer and the seller cannot make more transactions until the next round. The instructor’s screen also displays the standing buying and selling offers (Figure E). Look at it frequently for a general picture of standing offers and to get an idea of the price at which apples are being traded.

Instructor’s screen showing one completed transaction and standing buying and selling offers.

Figure E Instructor’s screen showing one completed transaction and standing buying and selling offers.

Instructions for Scenario 2 (sellers pay a €15 tax)

In Scenario 2, sellers have to pay an excise tax of €15 if they make a sale. (An excise tax is a per-unit tax imposed on a particular good or service.) If you are a supplier with Seller Cost and you sell a bushel of apples for price , then your profit from the transaction is . Remember, you only have to pay the tax if you sell your apples. If your cost of selling the bushel of apples (including taxes) is higher than the price you are offered, you are better off not selling and taking zero profits rather than selling for a loss.

A demander with Buyer Value who buys at price makes a profit of , and a profit of 0 if he does not buy.

Instructions for Scenario 3 (buyers pay a €15 tax)

In Scenario 3, buyers have to pay the excise tax of €15 if they buy a bushel of apples. If you are a demander with Buyer Value and you buy a bushel of apples for price , then your profit from the transaction is . Remember, you only have to pay the tax if you buy apples. If your cost of buying a bushel of apples (including taxes) is higher than your Buyer Value, you are better off not buying and taking zero profits rather than obtaining a loss.

A supplier with Seller Cost who sells at price makes a profit of , and a profit of 0 if she does not sell.

4.6 Predictions

Predicted results

Under the tab ‘prediction’, classEx provides graphs with the supply and demand curves and the competitive equilibrium predictions specific to your session. Figure 4.10 shows a particular example for a group of 52 students.

4.7 Discussion

A good discussion during and after the experiment is important. We like to return the tax revenue to students at the end of the experiment, once we have run all sessions. Returning the tax is consistent with the analysis of the excess burden or deadweight loss of a tax. (classEx does not return the tax, but you can easily calculate the per-capita tax return , where and are the number of transactions and the number of participants, respectively.) But before you return the tax, there are several issues that you should discuss with students.

Comments in the ‘Predictions’ and ‘What might go differently’ sections, and in The Economy (Section 8.7) provide useful further information.

Ask your students the following questions to frame the discussion.

4.8 Homework questions

These are also available in the students’ version.

These questions can be set for students to work on outside the classroom or can be completed and discussed in the classroom. They may help students reflect on their experience and understand their and others’ behaviour in the experiment.

For these questions, you have to provide your students with the following information: the distribution of Seller Costs and Buyer Values (from the tables in Figure 4.6 and Figure 4.7); and transactions, prices, and profits in the last round of each scenario (from a screenshot of the instructor’s screen or from the data file downloadable from classEx).

Data from your experiment can be downloaded as an Excel file from the ‘data’ menu in the instructor’s screen in classEx. You can also use this data to create your own questions. A description of the data variables can be found in the ‘Downloading the data from your experiment’ section.

Your instructor shared with you the following information regarding the experiment: transactions, prices, and profits in the last round of each scenario, and the distribution of Buyer Values and Seller Costs.

A simple competitive market (Scenario 1)

Exercise 8.3 in The Economy shows how to draw supply and demand ‘curves’ when they are step functions.

  1. Using the distribution of types, draw a graph showing both the demand and supply curves, and calculate the predictions of the theory for a competitive market.
  2. Find the theoretical predictions for price and quantity at the intersection of the demand and the supply curves. If competitive equilibrium theory predicts a range of possible equilibrium prices, use the midpoint of this range. Compute consumer surplus, producer profits, and total surplus (consumer + producer surplus).
  3. Use the data from your classroom experiment to calculate mean (average) price, the number of transactions, total profits of demanders, total profits of sellers, and total profits of all participants.
  4. Compare the experimental results in question 3 with the predictions made by the supply and demand theory in question 2.

A per-unit excise tax on sellers (Scenario 2)

  1. Use the data from your classroom experiment in Scenario 2 to calculate mean (average) price, the number of transactions, total profits of demanders, total profits of sellers, total taxes collected, and total profits of all participants plus taxes collected. (When computing total profits of buyers and sellers, do not include any tax revenue.)
  2. What was the effect of the tax collected from sellers on the average price? Did total profits of buyers and sellers fall more or less than the amount of tax revenue collected? Why do you think this happened?
  3. Copy the supply and demand graph for a market without taxes (that you drew for question 1 in Scenario 1). Add a dashed line to show the supply curve that applies when suppliers have to pay a tax of €15, as in Scenario 2. What effect did the tax have on the supply curve?
  4. Determine the theoretical prediction of the competitive equilibrium prices and quantities with and without the tax.
  5. Use the information in questions 1 and 2 to calculate total profits of buyers, total profits of sellers, and total taxes collected by the government. (Remember that here you are calculating the values predicted by competitive theory, not the actual outcomes observed in the experiment.)
  6. Calculate the excess burden as the difference between total profits without taxes and total profits plus tax revenue with a tax on sales.
  7. Compare the experimental results with the competitive predictions.
  8. Compare the price paid by buyers without and with the tax. Compare the effective price received by sellers without and with the tax (that is, the price received minus €15). Who actually paid (bore the burden of) the tax?

A per-unit excise tax on buyers (Scenario 3)

  1. Repeat the calculations in ‘A per-unit excise tax on sellers’ for the case when the tax is collected from buyers.
  2. Compare the distribution of the burden of the tax when sellers collected the tax and when the buyers collected the tax. Does it matter who collected the tax? If so, in what ways?

4.9 Further reading

Also available in the students’ version.