Question

John has been in the habit of mowing Willa's lawn each week for $20. John's opportunity cost is $15, and Willa would be willing to pay $25 to have her lawn mowed. What is the maximum tax the government can impose on lawn mowing without discouraging John and Willa from continuing their mutually beneficial arrangement?

Answer 1

The maximum tax that can be applied is: maximum willingness to pay - the opportunity cost = 25-15 = $10

When the amount is less than 10,then both parties will still benefit from the tax and so it will not discourage any party.

When the amount is more than 10,then at least one of them will be worse off and will stop the activity.

So,a tax of $10 will be where both the parties would be indifferent and will not discourage John and Willa from continuing their mutually beneficial agreement