CH20: Taxation

What are the two effects of taxes?

Raise revenue and change the behaviors of buyers

and sellers

How do you calculate tax revenue?

Tax revenue = Tax per unit × Quantity sold after tax

What happens to buyers when a tax is placed on a good?

Buyers pay a higher price and buy less of the good.

What happens to sellers when a tax is placed on a good?

Sellers receive a lower price and sell less of the good.

When sellers sell less because of a tax, what happens to deadweight loss?

DWL increases because fewer beneficial trades occur.

What does inelastic demand mean?

People continue buying a good even when the price

increases.

What are examples of inelastic goods?

Cigarettes, gasoline, alcohol, necessities, goods

with limited substitutes

What happens to quantity demanded for inelastic goods when prices increase?

Quantity decreases only a little.

Is DWL smaller with inelastic or elastic goods?

DWL is smaller with inelastic goods.

Is DWL larger with inelastic or elastic goods?

DWL is larger with elastic goods

What does elastic demand mean?

People stop buying a good when the price increases

What are examples of elastic goods?

Luxury goods, vacations, non-essential goods, goods

with many substitutes

What happens to quantity demanded for elastic goods when prices increase?

Quantity decreases a lot

Does the government collect more tax revenue from elastic or inelastic goods?

Inelastic goods

Does the government collect less tax revenue from elastic or inelastic goods?

Elastic goods

What happens to tax revenue when the price effect is greater than the quantity effect?

Tax revenue increases

If the government wants to raise revenue, what should it tax?

Inelastic goods

If the government wants to change behavior, what should it tax?

Elastic goods

Which side of the market pays more of the tax burden?

The less elastic side of the market

What is statutory incidence?

Who legally pays the tax

What is economic incidence?

Who actually bears the burden of the tax

What is a proportional tax?

A tax where everyone pays the same percentage

of their income

What is a progressive tax?

A tax where higher-income people pay a higher

percentage of their income

What is a regressive tax?

A tax where lower-income people pay a higher

percentage of their income

A government places a tax on gasoline. Consumers still buy gasoline even after the price increases. Is gasoline elastic or inelastic?

Inelastic

A government taxes luxury vacations, and many people stop buying vacations because prices increased. Is demand elastic or inelastic?

Elastic

Why does taxing inelastic goods create more revenue?

Because people continue buying the good even

after the tax increases the price.

Why does taxing elastic goods create more behavior change?

Because people are more likely to reduce their

purchases when prices increase.

If buyers are less sensitive to price changes than sellers, who pays more of the tax burden?

Buyers, because they are the less elastic side

Soft drinks with an elasticity of supply of 1 and an elasticity of demand of -2.5.

Sellers, because they are the less elastic side of the

market.

Mountain bikes with an elasticity of supply of 1.32 and an elasticity of demand of -3.5.

Sellers, because they are the less elastic side of the

market.

Cigarettes with an elasticity of supply of 2.5 and an elasticity of demand of -0.24.

Buyers, because they are the less elastic side of the

market.

More elastic means the curve is:

Less steep

Less elastic means the curve is:

More steep