Taxes and Welfare
In this section, we examine the effects on welfare of
changes in excise taxes.
The approach taken here, is to use the devices of
Producer and Consumer Surplus.
The social welfare from the production and
consumption of a particular amount of a good is
the sum of the producer surplus, consumer
surplus, and any tax revenue taken in by the
government.
Taxes, trade, & welfare
slide 1
What are the welfare effects of an excise
tax on beer?
P
S
P*
D
Q*
Q
BEER MARKET
Taxes, trade, & welfare
slide 2
CHANGE IN CS = -a - b
CHANGE IN PS = -c - d
TAX REVENUE OF GOV'T = a + c
S+t
So social cost = b + d
P
TAX
PER
UNIT
a
P*
c
S
b
d
D
Q*
Q
BEER MARKET
Taxes, trade, & welfare
slide 3
Economists call the loss in social welfare due to the
tax
THE DEADWEIGHT LOSS
from the tax.
Taxes, trade, & welfare
slide 4
Illustrating the deadweight loss
The following hidden slide shows the changes in
surplus and the deadweight loss due to an excise
tax.
Hidden slide
Taxes, trade, & welfare
slide 5
The size of the deadweight loss is determined by
1) The elasticity of the demand curve.
2) The elasticity of the supply curve.
3) The amount of the tax per unit.
Taxes, trade, & welfare
slide 7
The following hidden slide shows the effect of
demand elasticity on the size of the deadweight
loss in welfare due to an excise tax.
Hidden slide
Taxes, trade, & welfare
slide 8
Economists use terms such as "distortion of the
market" to describe the loss.
The deadweight loss is an example of an economic
inefficiency.
Taxes, trade, & welfare
slide 10
The following hidden slide shows the effect of
supply elasticity on the deadweight loss due to a tax.
Hidden slide
Taxes, trade, & welfare
slide 11
The following hidden slide shows the effect of
demand elasticity on the government’s tax revenue.
Hidden slide
Notice that this analysis can also be applied to
subsidies:
A per unit subsidy will create a DEADWEIGHT
LOSS in social welfare. In the case of the subsidy
too much of society's resources will be devoted to
the good.
Taxes, trade, & welfare
slide 15
Trade and Welfare
In this section, we examine the effects on welfare of
international trade.
The approach taken here, is to use the devices of
Producer and Consumer Surplus.
The change in social welfare when trade is allowed
can be measured by the changes in producer and
consumer surplus.
Taxes, trade, & welfare
slide 16
P
The diagram below shows the U.S.
domestic market for wine. No trade is
taking place.
S
P* = $10
D
Q*
Q
WINE MARKET
Taxes, trade, & welfare
slide 17
In the case of wine, let's suppose the world price is
lower than the U.S no-trade price, say, $8.00 per
bottle.
Taxes, trade, & welfare
slide 18
What happens with trade?
What are the welfare effects of trade?
P
S
P* = $10
P* = $8
D
Q' Q*
Taxes, trade, & welfare
Q"
WINE MARKET
Q
slide 19
U.S. consumers gain b + d.
U.S. producers lose b.
Welfare rises by d.
P
S
a
P* = $10
P* = $8
b
d
c
D
Q'
Taxes, trade, & welfare
Q"
WINE MARKET
Q
slide 20
The next (hidden) slide shows in a dynamic way who
gains from trade when the world price is below the
domestic, no trade price.
Hidden slide
P
The diagram below shows the U.S.
domestic market for computers. No
trade is taking place.
S
P* = $1500
D
Q*
Q
COMPUTER MARKET
Taxes, trade, & welfare
slide 23
Suppose computers can be sold for $2000
each on the world market and trade is
allowed.
What happens with trade?
What are the welfare effects of trade?
Taxes, trade, & welfare
slide 24
U.S. consumers lose b.
U.S. producers gain b + d.
Welfare rises by d.
P
S
a
P* = $2000
b
d
P* = $1500
c
D
Q*
Q
COMPUTER MARKET
Taxes, trade, & welfare
slide 25
The next (hidden) slide shows in a dynamic way who
gains from trade when the world price is above the
domestic, no trade price.
Hidden slide
Summary and conclusions
Allowing trade in a good will always increase social
welfare (the sum of producer and consumer
surplus).
When a good is exported, suppliers gain and
consumers lose, compared to the no trade position.
When a good is imported, suppliers lose and
consumers gain, compared to the no trade position.
Taxes, trade, & welfare
slide 28