YR1SM1 Microeconomics: Chapter 8 - The costs of taxation

When the government imposes a tax, which three parties now gain from the market?

buyers, sellers, and the government

How does tax impact total surplus?

Total surplus falls because tax causes market inefficiency and thus DWL. Units of a good are not being sold/bought even if they can be due to the undesirable price changes for both buyers and sellers

Deadweight loss is money …

lost entirely, not gained by any of the 3 parties (government, buyers, sellers)

Total tax revenue =

Tax amount (vertical tax rate) * equilibrium quantity post tax

How does tax act as a price change that decreases consumer surplus and producer surplus rather than increase them as in previous examples?

Tax acts as a price climb for buyers and as a price decline for sellers, meaning that from the old price to the new prices, the buyers whose WTP is between them will drop out, the sellers whose WTS is between them will drop out, and anyone still in the market won’t receive as much gain

How can a tax too high on buyers or sellers hurt everyone?

A tax on buyers means that they will only buy if the price/unit decreases by the tax amount. However, this price would be lower than sellers’ cost/WTS, leading to no trade and thus a loss of all potential total surplus. A tax on sellers means that they will only sell if they increase the price/unit by the tax amount. However, this price will be higher than buyers’ WTP, leading to no trade and thus a loss of all potential total surplus. With no trade occurring, the government loses out on any tax revenue

For a given demand, if the supply curve is more elastic (horizontal), what happens to the magnitude of the overall DWL and the loss of CS?

both are larger

Tax always creates an inefficient market, thus DWL

the most inelastic side, in this case the buyers, bear most of the tax burden and thus experience more loss

For a given supply curve, if the demand curve is more elastic (horizontal), what happens to the magnitude of the DWL overall and the loss in PS?

both are larger

Between a market with greater elasticity in its supply and demand vs a market with greater inelasticity in its supply and demand, which will suffer more DWL from the same tax amount and why?

The market with greater elasticity, because the quantity sold or bought will decrease more drastically due to its sensitivity to price

In order to increase tax revenue, should the government tax elastic or inelastic goods?

Inelastic goods, because the amount of trade does not decrease as much compared to the trade of elastic goods, meaning that there is more trade activity for the government to tax

Relationship between the tax size/rate and the DWL

an increase in tax size/rate leads to an exponential increase in DWL

Relationship between tax size and tax revenue

Up to an optimal point, tax revenue rises as tax size rises, but afterwards, tax revenue falls as tax size continues to rise

Laffer curve

a graph that plots tax size on the x-axis and tax revenue on the y-axis and whose concave shape shows the initial positive but later negative relationship between the two variables