Excise Tax: Analysis of a $1/unit excise tax
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S
Pe
D
0
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Excise Tax: Analysis of a $1/unit excise tax
Cigarettes
P
Here is the market for
cigarettes in equilibrium.
What will happen if a
1$/pack tax is enacted?
S
Pe
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0
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Excise Tax: Analysis of a $1/unit excise tax
Cigarettes
P
Here is the market for
cigarettes in equilibrium.
What will happen if a
1$/pack tax is enacted?
S
What will happen to
Demand as a result of
the tax?
Pe
NOTHING HAPPENS TO
DEMAND. Excise taxes
work like production
costs and affect SUPPLY.
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Excise Tax: Analysis of a $1/unit excise tax
St
Cigarettes
P
S
$7
Here is the market for
cigarettes in equilibrium.
What will happen if a
1$/pack tax is enacted?
What will happen to
Supply as a result of the
tax?
$6
Supply will move up (and
to the left). It will move
UP by the amount of the
tax.
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Excise Tax: Analysis of a $1/unit excise tax
St
Cigarettes
P
S
$7
Notice though, that the
PRICE does not go up by
the full amount of the
tax.
This shows that the tax
burden is shared by
consumers and
producers.
Pt
$6
Quantity also goes down,
as with any decrease in
supply.
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Qt
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Excise Tax: Analysis of a $1/unit excise tax
St
Cigarettes
P
S
OK, let’s assume that this
is split right down the
middle and the new
price is $6.50.
How much are
consumers now paying
for cigarettes?
$6.50
$6.50
$6
How much are producers
actually getting for
cigarettes?
$5.50 (They have to pay
the $1 tax.)
$5.50
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Compared to before,
each is paying exactly
half of the $1.00 tax.
Excise Tax: Analysis of a $1/unit excise tax
St
Cigarettes
P
S
To do that, we remove
the new Supply curve
(St).
$6.50
$6
$5.50
What happened to the
rest of it?
D
0
Let’s look at the areas of
consumer surplus,
producer surplus, and
deadweight loss after the
tax.
Qt
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Excise Tax: Analysis of a $1/unit excise tax
Cigarettes
P
S
Some of it goes to the
government in the form
of the tax.
What about the last
part?
$6.50
$6
$5.50
Tax Revenue
Tax Revenue
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0
Qt
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Excise Tax: Analysis of a $1/unit excise tax
Cigarettes
P
S
Some of it goes to the
government in the form
of the tax.
What about the last
part?
$6.50
$6
$5.50
You guessed it:
Deadweight Loss
Tax Revenue
Tax Revenue
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0
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Excise Tax: Analysis of a $1/unit excise tax
P
Cigarettes
$10
S
Original Consumer
Surplus?
New Consumer Surplus?
Original Producer
Surplus?
New Producer Surplus?
Tax Revenue?
Deadweight Loss?
$6.50
$6
$5.50
Tax Revenue
Tax Revenue
$2
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0
Let’s put some numbers
in here and do some
calculations:
90
Qt
100
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Excise Tax: Analysis of a $1/unit excise tax
St
Cigarettes
P
S
$7
$6.80
Price for cigarettes is
now $6.80. Consumers
pay 80% of the tax.
Producers only pay 20%
of the tax.
$6
$5.80
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0
When demand is very
inelastic, producers can
pass on more of the tax
to consumers.
Qt Qe
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Excise Tax: Analysis of a $1/unit excise tax
St
Cigarettes
P
S
$7
When demand is very
elastic, producers cannot
pass on much of the tax
to consumers.
Price for cigarettes is
now $6.20. Consumers
pay 20% of the tax.
Producers pay 80% of the
tax.
$6.20
$6
$5.20
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0
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