```Chapter 8
The Costs of Taxation
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Market Efficiency: Three observations
Free
markets allocate the supply of
goods to the buyers who value them
most highly.
Free markets allocate the demand for
goods to the sellers who can produce
them at least cost.
Free markets produce the quantity of
goods that maximizes the sum of
consumer and producer surplus.
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The Costs of Taxation
A
tax places a wedge
between the price
Tax!
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The Costs of Taxation
A
tax places a wedge
between the price
A tax results in a
society and the
economy
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Tax! Loss!
Supply
\$.50
Demand
1000
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Supply
\$.60
\$.20 tax
imposed
\$.50
\$.40
Demand
800 1000
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The
twenty cent tax results in new
prices to consumers and producers:
– Consumers pay \$0.60
The
Tax Revenue from the imposed tax
is = \$160
i.e. [(\$0.60-\$0.40) x 800]
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Tax Revenue
Supply
\$.60
\$.50
\$.40
Demand
800 1000
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The
tax places a wedge between the
price buyers pay and the price sellers
and the lower price to sellers results in
a lower quantity demanded and
quantity supplied.
The loss in quantity demanded and the
quantity supplied is 200 units (1000 800).
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Supply
\$.60
Loss = \$20
\$.50
\$.40
Demand
800 1000
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The
deadweight loss of 200 units do
no one any good
– The value of the loss to society due to the
twenty cent tax is = \$20
(\$500 \$480)
Taxes
sellers from realizing some of the
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The
depends upon how large a decline in
market exchange occurs as a result of
the tax.
The size in the decline in market
exchange depends upon how sensitive
consumers and producers are to
changes in prices: Elasticity Concept.
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The more elastic demand and
supply are, the greater will be the
decline in equilibrium quantity and
the greater the
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
More Elastic Demand and Supply
S0
PE
D0
QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
More Elastic Demand and Supply
S2
Amount
of Tax
S0
PE
D0
QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
More Elastic Demand and Supply
S2
Amount
of Tax
P2
S0
PE
D0
Q2
QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
More Elastic Demand and Supply
S2
Amount
of Tax
P2
S0
Loss!
PE
D0
Q2
QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
A
tax has a deadweight loss because it
induces buyers and sellers to change
their behaviour.
– Lower prices received causes sellers to
offer less.
The
size of the market shrinks below
the optimum.
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Less Elastic Demand and Supply
S0
PE
D0
QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Less Elastic Demand and Supply
S2
P2
S0
Amount of Tax
PE
D0
Q2 QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
Less Elastic Demand and Supply
S2
P2
S0
Amount of Tax
Loss!
PE
D0
Q2 QE
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The
deadweight loss of a tax rises
even more rapidly than the size of the
tax.
– It is related to the area of a triangle. If we
double the tax, the size of the triangle
increases four times.
With
each increase in the tax rate, tax
revenues will rise slowly, reach a
maximum, and decline.
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8
The Costs of Taxation: Conclusion
When
a tax is imposed on a good, the
tax reduces consumer and producer
surplus by an amount that is greater
than the tax revenue generated.
The difference between the decrease
in total consumer and producer
surplus and the tax revenue generated
is referred to as the Deadweight Loss
of a tax.
Principles of Microeconomics &amp; Principles of Macroeconomics: Ch.8