Transcript AP ECON CHAPTER 8 WIKI - mrski-apecon-2008

The costs of
taxation
Tax
Usually taxes are collected because
government wants to run the country.
Some people believe that all taxation creates
market distortion and results in economic
inefficiency.
Cause and effect
When there is a tax, then a deadweight loss is
created?
What is a deadweight loss?
Where the total surplus decrease due to the
presence of market distortion.
Deadweight loss
•
There is no difference 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 becomes less.
Who is better off?
Price
Also the total surplus decreases by
-(C+E) because C+E represents
Supply the deadweight loss.
A
Price buyers
pay
Size of tax
B
Price
without tax
Price sellers
receive
D
C
E
By looking at the graph we notice that C+E is the tax
revenue. Originally the consumer surplus is A+B+C.
However, after the presence of tax, the consumer
surplus decreases by -(B+C).
F
Demand
0
Quantity
with tax
Quantity
without tax
Quantity
Who is better off
• deadweight losses occurs
when taxes are in presence,
because they protect buyers
and sellers from realizing
some of the gains from trade.
How does tax affect the
market?
•
When there is a tax, the tax creates something called a wedge
between the buyers and sellers.
The size of the market for that good shrinks.
Tax revenue
Despite the fact that when there is a tax the
consumer, producer and total surplus all fall. A
tax revenue is created.
How to calculate the tax revenue
Tax Revenue
•
•
T = the size of the tax
•
Q = the quantity of the good sold
•
T  Q = the government’s tax revenue
Where is the tax
revenue?
Price
A
Price buyers
pay
Size of tax
B
Price
without tax
Price sellers
receive
Supply
D
C
E
B+D= Tax revenue
F
Demand
0
Quantity
with tax
Quantity
without tax
Quantity
Deadweight loss differs
Depending whether the supply or demand
curve is elastic or inelastic.
If it is elastic the deadweight loss is extremely
huge
if it is inelastic the deadweight loss is small
Inelastic supply curve
Price
Supply
When supply is relatively
inelastic, the
deadweight loss of a
tax is small
Size of tax
Demand
0
Quantity
When Supply curve is
elastic
(b) Elastic Supply
Price
Size
of
tax
When supply is relatively
elastic, the deadweight
loss of a tax is large
Supply
Demand
0
Quantity
Wait a second
If the tax gradually increases would the tax
revenue always gradually increase?
NO!!
• If the size of the tax continues to rise, tax revenue falls
because the higher tax reduces the size of the market.
What is the laffer
curve?
•
•
When the tax increases, the deadweight loss also gets larger
as well.
By contrast, tax revenue first rises with the size of a tax, but
then as the tax gets larger, the market shrinks so much that
tax revenue starts to fall. (Laffer curve)
Laffer curve
•
The Laffer curve depicts the relationship between tax rates
and tax revenue.
The laffer curve represents the relationship
between the tax revenue and the tax rate.
Summary
When a tax is in presence there is a fall in
consumer,producer and total surplus.
When a tax is in presence a deadweight loss
occurs.
Summary
Depending on whether the supply or demand
curve is elastic or inelastic, the deadweight
loss differs.
Tax revenue first rises as the tax is presence
Unfortunately, a larger tax reduces the tax
revenue, it reduces the market size.
Review questions
What does the laffer curve represent
What is a deadweight loss
How does tax effect the market, explain
Answers
The laffer curve represents the relationship
between the tax revenue and the tax rate.
There is no difference 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 becomes less.
When there is a tax, the tax creates something
called a wedge between the buyers and
sellers. The size of the market for that good
shrinks.