Transcript Taxes & Market Equilibrium

Tax Incidence & Elasticity
Who actually bears the burden of taxes?
Chapter 6 (pages 124-131)
Tax Incidence
• Tax incidence- is the study of who bears the burden of a tax
• Regardless of who pays the tax directly to the Gov’t => buyers &
sellers both bear some of the tax incidence (burden)
– Buyers pay a higher price
– Sellers Receive a lower price
Tax Incidence & Elasticity
• The degree of tax incidence (tax burden) depends on the relative
elasticity of demand versus elasticity of supply
• Bottom line: Tax incidence is greater on the more inelastic market
The Steeper Curve pays more of the tax!
Taxes & Shifting Supply/Demand
• A tax on sellers shifts the supply curve left by amount of tax
– End result is identical to drawing a “tax wedge”
• A tax on buyers shifts the demand curve left by amount of tax
– End result is identical to drawing a “tax wedge”
If Gov’t taxes Sellers
Seller pays Gov’t
Shift supply left
Buyer pays Gov’t
If Gov’t taxes Buyers
Shift demand left
$.50 Cent Tax on Sellers
Example #1
Price of
Ice-Cream
Price
Cone
buyers
pay
$3.30
3.00
Price
2.80
without
tax
S2
Equilibrium
with tax
S1
A tax on sellers
shifts supply
left by size of tax
($0.50)
Tax ($0.50)
Equilibrium without tax
Price
sellers
receive
D1
0
90
100
Quantity of
Ice-Cream Cones
Shifting Supply or Demand Curves
• Tax incidence does not depend on who the tax is “placed on”
– i.e. who “sends tax” to the Government
• Shifting the demand or supply curve is an “illusion”
– It only tells you who “paid” the Gov’t => not who “bears” the burden
• The end result of the tax in terms of DWL, Tax Revenue, Tax
Incidence is the same regardless of which curve you shift!
$.50 Cent Tax on Buyers
Price of
Ice-Cream
Price
Cone
buyers
pay
$3.30
Price
3.00
2.80
without
tax
Price
sellers
receive
Supply, S1
Equilibrium without tax
Tax ($0.50)
A tax on buyers
shifts demand
curve left by the
size of the tax
New Equilibrium
with tax
Buyers pay $0.30 of tax
Sellers pay $0.20 of tax
Result is the same as
When you taxed sellers!
0
90
100
D1
D2
Quantity of
Ice-Cream Cones
Tax Incidence Worksheet
Price
T-Shirts
$20
S1
-------------- E1
-------------
$10
100
D1
Qty
Inelastic Curves
• Tax incidence is higher on curve that is more inelastic
– Shifting a curve only tells you who “pays” tax
• Deadweight Loss is smaller for inelastic curves
• Tax revenue raised is higher
S
D
Inelastic Curves lead to:
1)
2)
3)
Higher tax incidence
Lower DWL
Higher Tax Revenue