Principles of economics 2nd by mankiw chapter 08

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Application: The Costs of Taxation Chapter Copyright © 2001 by Harcourt, Inc All rights reserved.   Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida 32887-6777 The Costs of Taxation How taxes affect the economic wellbeing of market participants? Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Costs of Taxation It does not matter whether a tax on a good is levied on buyers or sellers of the good…the price paid by buyers rises, and the price received by sellers falls Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Effects of a Tax Price Supply Price buyers pay Size of tax Price without tax Price sellers receive Demand Quantity Quantity with tax without tax Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity The Effects of a Tax A tax places a wedge between the price buyers pay and the price sellers receive ◆ Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax ◆ The size of the market for that good shrinks ◆ Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Tax Revenue T = the size of the tax Q = the quantity of the good sold T× Q = the government’s tax revenue Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Tax Revenue Price Supply Price buyers pay Size of tax (T) Tax Revenue (T x Q) Price sellers receive Quantity sold (Q) Quantity Quantity with tax without tax Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Demand Quantity How a Tax Affects Welfare Tax reduces consumer surplus by (B+C) and producer surplus by (D+E) Tax revenue = (B+D) Supply Price Price buyer s pay = PB A B Price withou = P1 t tax Price = PS sellers receiv e C Deadweight Loss = (C+E) E D F Demand Q2 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Q1 Quantity Changes in Welfare from a Tax Without Tax With Tax Change Consumer Surplus A+B+C A - (B + C) Producer Surplus D+E+F F - (D + E) Tax Revenue none B+D + (B + D) Total Surplus A+B+C+D+E+ F A+B+D+F - (C + E ) The area C+E shows the fall in total surplus and is the deadweight loss of the tax Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc How a Tax Affects Welfare The change in total welfare includes: ◆ The change in consumer surplus, ◆ The change in producer surplus, ◆ The change in tax revenue ◆ The losses to buyers and sellers exceed the revenue raised by the government ◆ This fall in total surplus is called the deadweight loss Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Summary ◆ As a tax grows larger, it distorts incentives more, and its deadweight loss grows larger ◆ Tax revenue first rises with the size of a tax ◆ Eventually, however, a larger tax reduces tax revenue because it reduces the size of the market Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Graphical Review Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Effects of a Tax Price Supply Price buyers pay Size of tax Price without tax Price sellers receive Demand Quantity Quantity with tax without tax Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Tax Revenue Price Supply Price buyers pay Size of tax (T) Tax Revenue (T x Q) Price sellers receive Quantity sold (Q) Quantity Quantity with tax without tax Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Demand Quantity How a Tax Affects Welfare Tax reduces consumer surplus by (B+C) and producer surplus by (D+E) Tax revenue = (B+D) Supply Price Price buyer s pay = PB A B Price withou = P1 t tax Price = PS sellers receiv e C Deadweight Loss = (C+E) E D F Demand Q2 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Q1 Quantity The Deadweight Loss Price Lost gains from trade PB Price = P1 without tax Supply Size of tax P S Cost to sellers Value to buyers Q2 Q1 Demand Quantity Reduction in quantity due to the Harcourt, Inc items and derived items copyright © 2001tax by Harcourt, Inc Tax Distortions and Elasticities Price (a) Inelastic Supply Supply When supply is relatively inelastic, the deadweight loss of a tax is small Size of tax Demand Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Tax Distortions and Elasticities (b) Elastic Supply Price When supply is relatively elastic, the deadweight loss of a tax is large Supply Size of tax Demand Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Tax Distortions and Elasticities (c) Inelastic Demand Price Supply Size of tax When demand is relatively inelastic, the deadweight loss of a tax is small Demand Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Tax Distortions and Elasticities (d) Elastic Demand Price Supply Size of tax When demand is relatively elastic, the deadweight loss of a tax is large Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Demand Quantity Deadweight Loss and Tax Revenue (a) Small Tax Price Supply Deadweight loss PB Tax revenue PS Demand Q2 Q1 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Deadweight Loss and Tax Revenue (b) Medium Tax Price Supply Deadweight loss PB Tax revenue PS Demand Q2 Q1 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Deadweight Loss and Tax Revenue (c) Large Tax Price Tax revenue PB Supply Deadweight loss Demand PS Q2 Q1 Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Quantity Deadweight Loss and Tax Revenue Vary with the Size of the Tax (a) Deadweight Loss Deadweight Loss Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Tax Size Deadweight Loss and Tax Revenue Vary with the Size of the Tax Tax Revenue (b) Revenue (the Laffer curve) Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc Tax Size ... or sellers of the good…the price paid by buyers rises, and the price received by sellers falls Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Effects of a Tax Price...The Costs of Taxation How taxes affect the economic wellbeing of market participants? Harcourt, Inc items and derived items copyright © 2001 by Harcourt, Inc The Costs of Taxation It does... © 2001 by Harcourt, Inc Tax Revenue T = the size of the tax Q = the quantity of the good sold T× Q = the government’s tax revenue Harcourt, Inc items and derived items copyright © 2001 by Harcourt,
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