IB Economics
HL Topics
Indirect Taxes,
Subsidies and Price
Controls
Tax Incidence (burden)
►Is
a measure of the consequences
of a tax on all the affected parties
►Tax impacts the profitability of any
product, the degree may vary
►Whoever pays the tax suffers the
tax burden
Tax incidence: PED similar to PES
Price
S + tax
S
Ptax
Pe
P1
Tax burden of
consumer
Tax Revenue
Tax burden of
producer
D
Qtax
Qe
Quantity
PED similar to PES
►Consumers
and producers share the
burden of tax equally
►Consumers pay more and receive less
output
►Consumer and producer surplus
decreased
►Market size was reduced from Qe to
Qtax
Tax incidence: PED > PES
Price
S + tax
S
Ptax
Pe
P1
Tax burden of
consumer
Tax
Revenue
Tax burden
of
producer
D
Qtax
Qe
Quantity
PED > PES
► Demand
is more elastic than supply
► Consumers are more responsive to price, and
therefore less tolerant of price increases
► Producers pay more of the burden of the tax
► Government receives less revenue
► Market size decreases quite significantly,
therefore employment is more likely to
decline
► Deadweight loss is greater due to large
decrease in quantity
Tax incidence: PED < PES
Price
S + tax
S
Ptax
Pe
P1
Tax burden of
consumer
Tax
Revenue
producer
D
Qtax
Qe
Quantity
PED < PES
►Consumers
are relatively indifferent to
price changes
►Consumers tax burden is greater than
producers
►Government receives more revenue
►Market size decreases relatively little,
therefore employment is less affected
►Deadweight loss is smaller
PED vs PES Summary
►The
more elastic the demand relative to
supply, the greater the burden paid by
producers, the greater the deadweight
loss, and the smaller the government
revenue
►The more inelastic the demand relative
to supply, the greater the burden paid
by consumers, the smaller the
deadweight loss, and the greater the
government revenue
►Government
will place indirect taxes on
products that have relatively inelastic
demand
 The demand will change in smaller
proportion, gain high revenue and yet not
cause a large fall in employment
Size of Deadweight Loss
►
The deadweight loss of the tax will depend upon two
factors:
 The size of the tax
 The reduction in the quantity sold
►
The reduction in the quantity sold will depend upon the
elasticity of demand and supply
 The more elastic demand or supply is the larger the deadweight
loss will be
 If either demand or supply is price inelastic then the deadweight
loss will be small and could be zero if perfectly inelastic (no change
in the quantity sold and consumed)
Total Welfare before Tax
Price
A + B + C = Consumer Surplus
(before tax)
Price
buyers = PB
pay
S = MC
A
B
C
Price
without tax = P1
Price
sellers = PS
receive
E1
E
D
E1 maximizes
Total Welfare
F
D = MB
Producer Surplus = D + E + F
0
Q2
Q1
(before tax)
QTY
Tax Affect on Total Welfare
Price
Area C + E is a complete loss to
Society: (DEADWEIGHT LOSS)
Price
buyers = PB
pay
S = MC
A
B
C
Price
without tax = P1
Price
sellers = PS
receive
E
D
F
D = MB
B+D
= Tax Revenue
0
Q2
Q1
Quantity
Tax incidence and
Linear Function
HL Page 107 Exercise
Additional graphs
Consumer Surplus
Price
Consumer Surplus
Maximum Willingness to Pay for Qo
Po
What is paid
D
Qo
Quantity
Change in Consumer Surplus:
Price Increase
Price
New Consumer Surplus
Original Consumer
Surplus
Loss in Surplus: Consumers paying more
P1
Po
Loss in Surplus: Consumers
buying less
D
Q1
Qo
Quantity
Producer Surplus
Price
S
Producer Surplus
Po
What is paid
Minimum Amount Needed to
Supply Qo
Qo
Quantity
Consumer and Producer
Surplus
Price
Consumer
Surplus
Po
S
Producer Surplus
D
Qo
Quantity
Loss in Efficiency
Too High of Price (Price Floor)
Price
Deadweight Loss
Lost
Consumer
Surplus
New Consumer
Surplus
S
PH
Po
Lost Producer Surplus
New Producer
Surplus
D
QL
Qo
Quantity
Loss in Efficiency
Too Low of Price (Price Ceiling)
Price
Deadweight Loss
Lost
Consumer
Surplus
S
New Consumer
Surplus
Po
Lost Producer Surplus
PL
New Producer
Surplus
D
QL
Qo
Quantity
Loss in Efficiency
Taxation
STax
Price
Tax
New Consumer
Surplus
Lost Consumer
Surplus
PD
Tax
Revenues
S
Po
Deadweight Loss
Lost Producer Surplus
PS
New Producer
Surplus
D
QL
Qo
Quantity
Subsidy
Loss in Efficiency
Subsidy
Price
S
Gain in Producer Surplus
New
Consumer
Surplus
PS
SSub
Subsidy
Gain in Consumer Po
Surplus
PD
New Producer
Surplus
Deadweight Loss
D
Subsidy Cost
Qo
QH
Quantity