CH8- The Costs of Taxation

Consumer surplus

The amount a buyer is willing to pay minus the price the buyer actually pays; the bonus value from buying

Producer surplus

The price a seller receives minus the seller's cost; the bonus value from selling

Total surplus (no tax)

Consumer surplus plus producer surplus; maximized at market equilibrium

Total surplus (with tax)

Consumer surplus plus producer surplus plus tax revenue

Tax wedge

The gap a tax creates between the price buyers pay and the price sellers receive; equal to the size of the tax

Price buyers pay (PB)

The higher price buyers pay after a tax; equals the price sellers receive plus the tax

Price sellers receive (PS)

The lower price sellers keep after a tax; equals the price buyers pay minus the tax

Tax revenue

Size of the tax times quantity sold (T × Q); shown as the rectangle between the supply and demand curves

Deadweight loss (DWL)

The fall in total surplus that results from a market distortion, such as a tax

Gains from trade

The difference between a buyer's value and a seller's cost for a transaction

Mutually beneficial transaction

A trade where the buyer's value is greater than the seller's cost, so both sides gain

Market distortion

A government policy, such as a tax or price control, that moves quantity away from equilibrium and reduces total surplus

Efficiency

An allocation of resources that maximizes total surplus

Elastic supply or demand and DWL

The more elastic supply or demand is, the larger the deadweight loss of a tax

Inelastic supply or demand and DWL

The more inelastic supply or demand is, the smaller the deadweight loss of a tax

Tax efficiency

Highest when taxing a good with very inelastic supply or demand

Long-run deadweight loss

DWL of a tax grows over time because supply and demand become more elastic in the long run

Laffer curve

The relationship between tax size and tax revenue; revenue first rises, then falls as the tax grows

Deadweight loss and tax size

DWL keeps rising as the tax grows, and rises faster than the tax itself (doubling a tax roughly quadruples DWL)

Black market

An illegal market that can emerge when a tax is extremely large, causing official tax revenue to fall toward zero

A tax drives a _____ between the price buyers pay and the price sellers receive.

wedge

Tax revenue equals the size of the tax times the _____ sold.

quantity

The fall in total surplus caused by a tax is called _____ loss.

deadweight

Without a tax, total surplus is maximized at market _____.

equilibrium

Because buyers pay a higher price after a tax, consumer surplus _____.

falls

The more elastic supply and demand are, the _____ the deadweight loss of a tax.

larger

When supply is perfectly inelastic and quantity doesn't change, deadweight loss equals _____.

zero

The curve showing tax revenue first rising and then falling as the tax grows is the _____ curve.

Laffer

On a supply and demand graph, tax revenue is shown as the area of a _____.

rectangle

On a supply and demand graph, deadweight loss is shown as the area of a _____.

triangle

Taxes cause deadweight loss because they prevent buyers and sellers from realizing their gains from _____.

trade

Supply and demand become more elastic in the _____ run, so deadweight loss grows over time.

long

With linear curves, doubling a tax causes deadweight loss to _____.

quadruple

In Figure 3, consumer surplus after the tax is area _____.

A

In Figure 3, producer surplus after the tax is area _____.

F

When the government taxes a good, it makes the allocation of resources less _____.

efficient

A huge tax may raise no revenue because goods never sell or a _____ market emerges.

black

Trades are not made when gains from trade are less than the _____ amount.

tax

What does deadweight loss measure?

The fall in total surplus caused by a market distortion such as a tax

When a tax is imposed, what happens to the quantity sold?

It falls below the equilibrium quantity

Which formula gives tax revenue?

Size of the tax × quantity sold with the tax

Who loses surplus when a tax is imposed?

Both buyers and sellers

Which market has the smallest deadweight loss from a tax?

One with very inelastic supply and demand

Why do taxes cause deadweight loss?

They block trades whose gains from trade are smaller than the tax

As a tax keeps increasing, what happens to deadweight loss?

It keeps rising, faster than the tax

As a tax keeps increasing, what happens to tax revenue?

It first rises, then falls

What does the Laffer curve show?

The relationship between the size of a tax and tax revenue

How does the deadweight loss of a tax change over time?

It grows because supply and demand become more elastic in the long run

With a tax, total surplus equals what?

Consumer surplus + producer surplus + tax revenue

What are gains from trade?

The difference between a buyer's value and a seller's cost

Demand is P = 30 − Q and supply is P = 6 + Q. What are the equilibrium quantity and price with no tax?

Q = 12, P = $18

Demand is P = 30 − Q and supply is P = 6 + Q. What is total surplus with no tax?

$144

Demand is P = 30 − Q and supply is P = 6 + Q. A $6 per-unit tax is imposed. What quantity is sold?

9 units

Demand is P = 30 − Q and supply is P = 6 + Q. With a $6 per-unit tax, what price do buyers pay and sellers receive?

Buyers pay $21, sellers receive $15

Demand is P = 30 − Q and supply is P = 6 + Q. With a $6 per-unit tax, what is tax revenue?

$54

Demand is P = 30 − Q and supply is P = 6 + Q. With a $6 per-unit tax, what is deadweight loss?

$9

Demand is P = 30 − Q and supply is P = 6 + Q. With a $6 per-unit tax, what is consumer surplus?

$40.50

Demand is P = 30 − Q and supply is P = 6 + Q. If the tax rises to $12 per unit, what is deadweight loss?

$36

Demand is P = 50 − 2Q and supply is P = 10 + 2Q. With an $8 per-unit tax, what are tax revenue and deadweight loss?

Tax revenue $64, DWL $8

Demand is P = 50 − 2Q and supply is P = 10 + 2Q. With an $8 per-unit tax, what is total surplus including tax revenue?

$192

Buyers' willingness to pay is $20, $15, $10, and $6; sellers' costs are $4, $8, $11, and $14. At a price of $10.50, what are CS and PS?

CS = $14, PS = $9

Using the same buyers and sellers, an $8 tax makes buyers pay $14 and sellers receive $6. What is the deadweight loss?

$7

A tax rises from $2 to $3 per unit and quantity sold falls from 500 to 400 units. How does tax revenue change?

Rises by $200

A tax rises from $10 to $15 per unit and quantity sold falls from 200 to 100 units. How does tax revenue change?

Falls by $500

A $3 per-unit tax reduces quantity sold from 40 to 30 units. What is the deadweight loss?

$15

With linear supply and demand, a $2 tax creates $50 of deadweight loss. What is the DWL if the tax rises to $4?

$200