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The Effects of a Tax
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Tax revenue can fund beneficial services (e.g. education, roads, police), so we include it in total surplus
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Deadweight Loss
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The fall in total surplus that results from a market distortion, such as a tax
-because of the tax, the units in the deadweight loss are unable to be sold (the value of these units to buyers is greater than the cost of producing them)
-because of the tax, the units in the deadweight loss are unable to be sold (the value of these units to buyers is greater than the cost of producing them)
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What determines the size of the DWL?
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-tax the goods and services with the smallest DWL
-the size of the DWL is small vs. large depending on the elasticity of supply and demand
-the size of the DWL is small vs. large depending on the elasticity of supply and demand
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DWL and the elasticity of supply
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When supply is inelastic, it's harder for firms to leave the market
-the tax only reduces Q a small distortion and DWL is small
The more elastic the supply, the easier for firms to leave the market
-large distortion, greater DWL
-the tax only reduces Q a small distortion and DWL is small
The more elastic the supply, the easier for firms to leave the market
-large distortion, greater DWL
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DWL and the elasticity of demand
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When demand is inelastic, it's harder for consumers to leave the market
-tax only reduces a little (small distortion, DWL is small
When the demand is more elastic, the easier it is for buyers to leave the market
-large distortion, DWL is greater
-tax only reduces a little (small distortion, DWL is small
When the demand is more elastic, the easier it is for buyers to leave the market
-large distortion, DWL is greater
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Government's Tax Revenue
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Represented by the rectangle between the supply curve and the demand curve
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Without a Tax
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Without a tax, the equilibrium would be found at the intersection of the supply and demand curves
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Consumer Surplus location
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The area between the demand curve and the price
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Producer Surplus location
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The area between the supply curve and the price
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How big should the government be?
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A bigger government provides more services, but requires higher taxes, which cause DWL's
-The larger the DWL from taxation, the greater the argument for smaller government
-The larger the DWL from taxation, the greater the argument for smaller government
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Revenue and the size of the tax
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When the tax is larger, increasing it will cause the tax revenue to fall
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Laffer curve
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Shows the relationship between the size of the tax and tax revenue
-Low level of taxes will increase tax revenue
-High taxes and continuing to increase them will continue to decrease tax revenue
-Low level of taxes will increase tax revenue
-High taxes and continuing to increase them will continue to decrease tax revenue
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Subsidy
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Reducing the input costs of a good (shifts the supply curve)
-distorts the market by increasing the quantity bought and sold
-benefits both the producer and the consumer
-the opposit
-distorts the market by increasing the quantity bought and sold
-benefits both the producer and the consumer
-the opposit
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Summary
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A tax on a good reduced the welfare of buyers and sellers
-this welfare loss usually exceeds the revenue the tax raises for the gov't
-the fall in total surplus is the called the deadweight loss of the tax
-DWL causes consumers to buy less and producers to sell less thus shrinking the market below the level htat maximizes total surplus
-this welfare loss usually exceeds the revenue the tax raises for the gov't
-the fall in total surplus is the called the deadweight loss of the tax
-DWL causes consumers to buy less and producers to sell less thus shrinking the market below the level htat maximizes total surplus
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