1、 2009 South-Western,a part of Cengage Learning,all rights reservedC H A P T E REconomicsPremium PowerPoint Slides by Ron Cronovich8How does a tax affect consumer surplus,producer surplus,and total surplus?What is the deadweight loss of a tax?What factors determine the size of this deadweight loss?Ho
2、w does tax revenue depend on the size of the tax?1APPLICATION:THE COSTS OF TAXATION2Review from Chapter 6A tax drives a wedge between the price buyers pay and the price sellers receive.raises the price buyers pay and lowers the price sellers receive.reduces the quantity bought&sold.These effects are
3、 the same whether the tax is imposed on buyers or sellers,so we do not make this distinction in this chapter.APPLICATION:THE COSTS OF TAXATION3QTThe Effects of a TaxPQDSEqm with no tax:Price=PE Quantity=QE PSPBPEQEEqm with tax=$T per unit:Sellers receive PS Quantity=QT Buyers pay PB Size of tax=$TAP
4、PLICATION:THE COSTS OF TAXATION4The Effects of a TaxPQDSRevenue from tax:$T x QT PSPBPEQEQTSize of tax=$TAPPLICATION:THE COSTS OF TAXATION5The Effects of a TaxNext,we apply welfare economics to measure the gains and losses from a tax.We determine consumer surplus(CS),producer surplus(PS),tax revenue
5、,and total surplus with and without the tax.Tax revenue can fund beneficial services(e.g.,education,roads,police)so we include it in total surplus.APPLICATION:THE COSTS OF TAXATION6The Effects of a TaxPQDSWithout a tax,PEQEQTABCDEFCS=A+B+CPS=D+E+FTax revenue=0Total surplus=CS+PS=A+B+C +D+E+FAPPLICAT
6、ION:THE COSTS OF TAXATION7The Effects of a TaxPQDSPSPBQEQTABCDEFCS=APS=FTax revenue =B+DTotal surplus=A+B +D+FWith the tax,The tax reduces total surplus by C+EAPPLICATION:THE COSTS OF TAXATION8The Effects of a TaxPQDSPSPBQEQTABCDEFC+E is called the deadweight loss(DWL)of the tax,the fall in total su
7、rplus that results from a market distortion,such as a tax.APPLICATION:THE COSTS OF TAXATION9About the Deadweight LossPQDSPSPBQEQTBecause of the tax,the units between QT and QE are not sold.The value of these units to buyers is greater than the cost of producing them,so the tax prevents some mutually
8、 beneficial trades.10A.Compute CS,PS,and total surplus without a tax.B.If$100 tax per ticket,compute CS,PS,tax revenue,total surplus,and DWL.DSPQ$The market for airplane tickets11DSCS=x$200 x 100=$10,000PQ$Total surplus=$10,000+$10,000=$20,000PS=x$200 x 100=$10,000P=The market for airplane tickets12
9、DSCS=x$150 x 75=$5,625PQ$Total surplus=$18,750PS=$5,625Tax revenue=$100 x 75=$7,500DWL=$1,250PS=PB=A$100 tax on airplane ticketsAPPLICATION:THE COSTS OF TAXATION13What Determines the Size of the DWL?Which goods or services should govt tax to raise the revenue it needs?One answer:those with the small
10、est DWL.When is the DWL small vs.large?Turns out it depends on the price elasticities of supply and demand.Recall:The price elasticity of demand(or supply)measures how much QD(or QS)changes when P changes.APPLICATION:THE COSTS OF TAXATION14When supply is inelastic,its harder for firms to leave the m
11、arket when the tax reduces PS.So,the tax only reduces Q a little,and DWL is small.DWL and the Elasticity of SupplyPQDSSize of taxAPPLICATION:THE COSTS OF TAXATION15DWL and the Elasticity of SupplyPQDSSize of taxThe more elastic is supply,the easier for firms to leave the market when the tax reduces
12、PS,the greater Q falls below the surplus-maximizing quantity,the greater the DWL.APPLICATION:THE COSTS OF TAXATION16DWL and the Elasticity of DemandPQDSSize of taxWhen demand is inelastic,its harder for consumers to leave the market when the tax raises PB.So,the tax only reduces Q a little,and DWL i
13、s small.APPLICATION:THE COSTS OF TAXATION17DWL and the Elasticity of DemandPQDSSize of taxThe more elastic is demand,the easier for buyers to leave the market when the tax increases PB,the more Q falls below the surplus-maximizing quantity,and the greater the DWL.Would the DWL of a tax be larger if
14、the tax were on:A.Breakfast cereal or sunscreen?B.Hotel rooms in the short run or hotel rooms in the long run?C.Groceries or meals at fancy restaurants?18A.Breakfast cereal or sunscreenFrom Chapter 5:Breakfast cereal has more close substitutes than sunscreen,so demand for breakfast cereal is more pr
15、ice-elastic than demand for sunscreen.So,a tax on breakfast cereal would cause a larger DWL than a tax on sunscreen.19B.Hotel rooms in the short run or long runFrom Chapter 5:The price elasticities of demand and supply for hotel rooms are larger in the long run than in the short run.So,a tax on hote
16、l rooms would cause a larger DWL in the long run than in the short run.20C.Groceries or meals at fancy restaurantsFrom Chapter 5:Groceries are more of a necessity and therefore less price-elastic than meals at fancy restaurants.So,a tax on restaurant meals would cause a larger DWL than a tax on groc
17、eries.21The government must raise tax revenue to pay for schools,police,etc.To do this,it can either tax groceries or meals at fancy restaurants.Which should it tax?22APPLICATION:THE COSTS OF TAXATION23How Big Should the Government Be?A bigger government provides more services,but requires higher ta
18、xes,which cause DWLs.The larger the DWL from taxation,the greater the argument for smaller government.The tax on labor income is especially important;its the biggest source of govt revenue.For the typical worker,the marginal tax rate(the tax on the last dollar of earnings)is about 40%.How big is the
19、 DWL from this tax?It depends on elasticity.APPLICATION:THE COSTS OF TAXATION24How Big Should the Government Be?If labor supply is inelastic,then this DWL is small.Some economists believe labor supply is inelastic,arguing that most workers work full-time regardless of the wage.APPLICATION:THE COSTS
20、OF TAXATION25How Big Should the Government Be?Other economists believe labor taxes are highly distorting because some groups of workers have elastic supply and can respond to incentives:Many workers can adjust their hours,e.g.,by working overtime.Many families have a 2nd earner with discretion over
21、whether and how much to work.Many elderly choose when to retire based on the wage they earn.Some people work in the“underground economy”to evade high taxes.APPLICATION:THE COSTS OF TAXATION26The Effects of Changing the Size of the TaxPolicymakers often change taxes,raising some and lowering others.W
22、hat happens to DWL and tax revenue when taxes change?We explore this next.APPLICATION:THE COSTS OF TAXATION27Q2Q1DWL and the Size of the TaxPQDScauses the DWL to more than double.Doubling the tax2TTInitially,the tax is T per unit.initial DWLnew DWLAPPLICATION:THE COSTS OF TAXATION28Q3DWL and the Siz
23、e of the TaxPQDSQ13TTcauses the DWL to more than triple.Tripling the taxInitially,the tax is T per unit.initial DWLnew DWLAPPLICATION:THE COSTS OF TAXATION29DWL and the Size of the TaxDWLTax sizeSummaryWhen a tax increases,DWL rises even more.ImplicationWhen tax rates are low,raising them doesnt cau
24、se much harm,and lowering them doesnt bring much benefit.When tax rates are high,raising them is very harmful,and cutting them is very beneficial.APPLICATION:THE COSTS OF TAXATION30Q2Revenue and the Size of the TaxPQDSQ1PBPSPBPS2TTWhen the tax is small,increasing it causes tax revenue to rise.APPLIC
25、ATION:THE COSTS OF TAXATION31Q3Revenue and the Size of the TaxPQDSQ2PBPSPBPS3T2TWhen the tax is larger,increasing it causes tax revenue to fall.APPLICATION:THE COSTS OF TAXATION32The Laffer curve shows the relationship between the size of the tax and tax revenue.Revenue and the Size of the TaxTax si
26、zeTax revenueThe Laffer curveA tax on a good reduces the welfare of buyers and sellers.This welfare loss usually exceeds the revenue the tax raises for the govt.The fall in total surplus(consumer surplus,producer surplus,and tax revenue)is called the deadweight loss(DWL)of the tax.A tax has a DWL be
27、cause it causes consumers to buy less and producers to sell less,thus shrinking the market below the level that maximizes total surplus.33The price elasticities of demand and supply measure how much buyers and sellers respond to price changes.Therefore,higher elasticities imply higher DWLs.An increa
28、se in the size of a tax causes the DWL to rise even more.An increase in the size of a tax causes revenue to rise at first,but eventually revenue falls because the tax reduces the size of the market.34APPLICATION:THE COSTS OF TAXATION35Problems and Applications:5.Suppose that the government imposes a
29、 tax on heating oil.a.Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year?Explain.b.Would the revenue collected from this tax likely be greater in the first year after it is imposed or in the fifth year?Explain.35APPLICATION:THE COSTS
30、OF TAXATION369.Suppose the government currently raises$100 million through a 1-cent tax on apples,and another$100 million through a 10-cent tax on oranges.If the government doubled the tax rate on apples and eliminated the tax on oranges,would it raise more money than today,less money,or the same amount of money?Explain.36
