Microeconomics – Deadweight Loss & Cost of Taxation (lecture 7)

the fall in total surplus that results from a market distortion, such as a tax. Units that are not sold.

(change in total surplus from before to after tax)

calculate DWL:

total surplus before tax - total surplus after tax = DWL

Consumer Surplus + Producer Surplus = Total Surplus

CS + PS = TS

includes tax revenue, but not deadweight loss

It depends on the price elasticities of supply and demand.

Supply/demand is inelastic = DWL small

Supply/demand is elastic = DWL large

(larger decline in equilibrium so greater DWL)

raising LOW tax rates = doesn't cause much harm

lowering LOW tax rates = doesn't bring much benefit

raising HIGH tax rates = harmful (DWL rises)

Doubling the tax = DWL more than doubles

lowering HIGH tax rates = very beneficial

LOW tax rates = tax revenue is small

raising LOW tax rates = tax revenue rises

but

raising HIGH tax rates = tax revenue falls

because higher tax reduces size of market

*see laffer curve*

depicts the relationship between tax rates and tax revenue

tax revenue rises with size of tax, but as tax raises further, the market shrinks so revenue starts to fall

a tax of a specific amount on each unit of a product sold

difference of total tax area (ex: 16 - 6= $10)

CS + PS + Total tax revenue = TS after tax