Which of the following best describes the effect of a tax imposed on a market in terms of resource allocation?

• A. Taxes can lead to a deadweight loss by causing resources to be allocated less efficiently.
• B. Taxes always increase the total surplus in a market by redistributing income.
• C. Taxes ensure that resources are allocated according to consumer preferences.
• D. Taxes have no impact on the allocation of resources in a market.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of resource allocation in a market, which refers to how resources are distributed to produce goods and services that satisfy consumer preferences efficiently.
2. Step 2: Recognize that a tax imposed on a market typically increases the price buyers pay and decreases the price sellers receive, creating a wedge between supply and demand.
3. Step 3: Analyze how this price wedge reduces the quantity traded below the market equilibrium quantity, leading to fewer mutually beneficial trades between buyers and sellers.
4. Step 4: Identify that this reduction in trade causes a loss of total surplus (the sum of consumer and producer surplus) that is not offset by tax revenue, known as deadweight loss.
5. Step 5: Conclude that because of deadweight loss, taxes can cause resources to be allocated less efficiently, meaning the market moves away from the optimal allocation that maximizes total surplus.