Taxes + Subsidies

What is an excise tax?

A fixed tax imposed per unit of a good bought or sold.

What happens graphically when an excise tax is imposed on producers?

The supply curve shifts upward or left by the amount of the tax.

What happens graphically when an excise tax is imposed on consumers?

The demand curve shifts downward or left by the amount of the tax.

What is the tax wedge?

The difference between the price buyers pay and the price sellers receive.

How large is the tax wedge for a per-unit tax?

Equal to the tax per unit.

Does who legally pays the tax determine who economically bears the tax?

No.

What is tax incidence?

How the economic burden of a tax is divided between consumers and producers.

What determines tax incidence?

The relative elasticities of supply and demand.

Which side of the market bears more of a tax?

The relatively more inelastic side.

Why does the more inelastic side bear more of a tax?

It is less able to change its quantity in response to the tax.

If demand is more inelastic than supply who bears more of the tax?

Consumers.

If supply is more inelastic than demand who bears more of the tax?

Producers.

What happens to the quantity traded after a typical excise tax?

It decreases.

Why does a tax create deadweight loss?

It prevents some mutually beneficial trades from occurring.

What is government tax revenue?

Tax per unit multiplied by the quantity sold after the tax.

Where is government tax revenue on a tax graph?

The rectangle defined by the tax wedge and the after-tax quantity.

What is the formula for government tax revenue?

Tax per unit times after-tax quantity.

Where is tax DWL on a standard graph?

The triangle representing lost trades between the after-tax quantity and original equilibrium quantity.

Why might governments impose taxes even though they can create DWL?

To raise revenue fund public programs redistribute resources or address external costs.

How does elasticity affect tax DWL?

More elastic supply or demand generally causes a larger quantity response and greater DWL for a given tax.

What is an ad valorem tax?

A tax equal to a percentage of a good's value or price.

How is an excise tax different from an ad valorem tax?

Excise is a fixed amount per unit while ad valorem is a percentage of value.

What is a subsidy?

A government payment that lowers the effective cost of buying or producing a good.

How can a subsidy be modeled relative to a tax?

As a negative tax that creates a wedge in the opposite direction.

What generally happens to quantity traded after a subsidy?

Quantity traded increases.