Chapter 8 - Application: The Costs of Taxation
How Tax Affects Market Participants:
Benefit for buyers is measured by consumer surplus- the amount buyers are willing to pay for the good minus the amount they actually pay for
Benefit for sellers is measured by producer surplus- the amount sellers receive for the good minus their costs (Chapter 7 Review)
The government gets total tax revenue of T (the size of the tax) multiplies Q (the quantity of the good sold)
Tax revenue can be used to produce services, such as roads, police, public education, or to help the ones in need, etc
We use the government’s tax revenue to measure the public benefit from tax
Welfare without tax= no tax revenue
Welfare with tax= price paid by buyers rises and government collects tax revenue
Change in Welfare
Deadweight loss- the fall in total surplus that results from a market distortion, such as a tax
When a tax raises the price to buyers and lowers the price to sellers, it distorts incentives and causes markets to allocate resources inefficiently
Deadweight Losses and the Gains from Trade:
Taxes cause deadweight losses It prevents buyers and sellers from realizing some of the gains from trade
The gains
The difference between buyers’ value and sellers’ cost is less than the tax
The price elasticities of supply and demand
Determines whether the deadweight loss from a tax is large or small
The Deadweight Loss Debate:
Economists argue that labor taxes do not greatly distort market outcomes and believe that labor supply is fairly inelastic. Some examples are…
Many workers can adjust the number of hours they work for a higher or lesser wage
Some families have second earners who have often married women with children
Elderlies retiring and their wages are all up to their own decisions
Some people engage in illegal economic activity to avoid paying taxes
Known as the underground economy
Many disagreements in whether the government should provide more services or reduce the tax burden
This is because of different views about the elasticity of labor supply and the deadweight loss of taxations
Taxes fluctuates
As the size of tax increases, its deadweight loss quickly gets larger
How Tax Affects Market Participants:
Benefit for buyers is measured by consumer surplus- the amount buyers are willing to pay for the good minus the amount they actually pay for
Benefit for sellers is measured by producer surplus- the amount sellers receive for the good minus their costs (Chapter 7 Review)
The government gets total tax revenue of T (the size of the tax) multiplies Q (the quantity of the good sold)
Tax revenue can be used to produce services, such as roads, police, public education, or to help the ones in need, etc
We use the government’s tax revenue to measure the public benefit from tax
Welfare without tax= no tax revenue
Welfare with tax= price paid by buyers rises and government collects tax revenue
Change in Welfare
Deadweight loss- the fall in total surplus that results from a market distortion, such as a tax
When a tax raises the price to buyers and lowers the price to sellers, it distorts incentives and causes markets to allocate resources inefficiently
Deadweight Losses and the Gains from Trade:
Taxes cause deadweight losses It prevents buyers and sellers from realizing some of the gains from trade
The gains
The difference between buyers’ value and sellers’ cost is less than the tax
The price elasticities of supply and demand
Determines whether the deadweight loss from a tax is large or small
The Deadweight Loss Debate:
Economists argue that labor taxes do not greatly distort market outcomes and believe that labor supply is fairly inelastic. Some examples are…
Many workers can adjust the number of hours they work for a higher or lesser wage
Some families have second earners who have often married women with children
Elderlies retiring and their wages are all up to their own decisions
Some people engage in illegal economic activity to avoid paying taxes
Known as the underground economy
Many disagreements in whether the government should provide more services or reduce the tax burden
This is because of different views about the elasticity of labor supply and the deadweight loss of taxations
Taxes fluctuates
As the size of tax increases, its deadweight loss quickly gets larger
