Compare the effects of a per-unit tax versus a lump-sum tax on market outcomes.

• A. A per-unit tax is non-distortionary.
• B. A lump-sum tax reduces the quantity.
• C. A lump-sum tax distorts incentives.
• D. A per-unit tax distorts incentives and reduces quantity, whereas a lump-sum tax is non-distortionary.

Answer: (D)

The key idea is whether a tax changes the marginal incentives that determine how much to produce or buy. A per-unit tax adds a constant cost for each unit, so it shifts the supply curve upward by the tax amount. That raises the price buyers pay, lowers the price sellers receive, and reduces the quantity traded. Because it changes the marginal costs and benefits that drive decisions, it distorts incentives and lowers output, creating a deadweight loss.

A lump-sum tax, by contrast, is a fixed amount that does not depend on how much is produced or consumed. It does not alter marginal costs or marginal benefits, so the decisions about how much to produce or buy stay the same as in a no-tax world. It is non-distortionary with respect to market activity, though it still raises revenue for the government.

So the per-unit tax distorts incentives and reduces quantity, while a lump-sum tax is non-distortionary.