6: cost of taxation Flashcards

1
Q

WHICH GOODS OR SERVICES SHOULD GOVT TAX
TO RAISE THE REVENUE IT NEEDS?

A

THOSE WITH THE SMALLEST DWL.

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2
Q

WHEN IS THE DWL SMALL VS. LARGE?

A

TURNS OUT IT DEPENDS ON THE PRICE ELASTICITIES
OF SUPPLY AND DEMAND.

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3
Q

WHAT DETERMINES THE SIZE OF THE DWL?

A

THE PRICE ELASTICITY OF DEMAND (OR SUPPLY) MEASURES HOW MUCH QD (OR QS) CHANGES
WHEN P CHANGES.

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4
Q

WHEN SUPPLY
IS INELASTIC,

A

IT’S HARDER FOR FIRMS
TO LEAVE THE MARKET
WHEN THE TAX REDUCES
PS

SO, THE TAX ONLY
REDUCES Q A LITTLE,
AND DWL IS SMALL.

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5
Q

The more elastic is supply,

A

the easier for firms
to leave the market when
the tax reduces PS

the greater Q falls below the
surplus-maximizing quantity,
the greater the DWL.

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6
Q

When demand
is inelastic,

A

it’s harder for consumers to
leave the market when the tax
raises PB

So, the tax only reduces Q a
little, and DWL is small.

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7
Q

The more elastic is demand,

A

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.

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8
Q

A BIGGER GOVERNMENT PROVIDES MORE SERVICES,
BUT REQUIRES HIGHER TAXES, WHICH CAUSE DWLS.

A
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9
Q

THE LARGER THE DWL FROM TAXATION,
THE GREATER THE ARGUMENT FOR SMALLER GOVERNMENT.

A
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10
Q

THE TAX ON LABOR INCOME IS ESPECIALLY IMPORTANT; IT’S THE BIGGEST SOURCE
OF GOVT REVENUE.

A
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11
Q

MARGINAL TAX RATE

A

(THE TAX ON THE LAST DOLLAR OF EARNINGS) IS ABOUT 40%.

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12
Q

HOW BIG IS THE DWL FROM THIS TAX?

A

IT DEPENDS ON ELASTICITY….

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13
Q

IF LABOR SUPPLY IS INELASTIC, THEN THIS DWL IS SMALL.

A
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14
Q

Welfare without a tax

A

the equilibrium price and quantity are found at the intersection of the
supply and demand curves.

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15
Q

Welfare without a tax

A
  • The demand curve reflects buyers’ willingness to pay, consumer surplus is the area between
    the demand curve and the price, A + B + C
  • The supply curve reflects sellers’ costs, producer surplus is the area between the supply
    curve and the price, D + E + F
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16
Q

Welfare with a tax

A

welfare after the tax is enacted.

17
Q

Welfare with a tax

A
  • The price paid by buyers rises from P1 to PB, so consumer surplus now equals only area a.
  • The price received by sellers falls from P1 to PS, so producer surplus now equals only area f.
  • To compute total surplus with the tax, we add consumer surplus, producer surplus, and tax
    revenue. Thus, we find that total surplus is area A + B + D + F
18
Q

CHANGES IN WELFARE

A
  • THE CHANGE IN TOTAL WELFARE INCLUDES THE CHANGE IN CONSUMER
    SURPLUS (WHICH IS NEGATIVE), THE CHANGE IN PRODUCER SURPLUS
    (WHICH IS ALSO NEGATIVE), AND THE CHANGE IN TAX REVENUE (WHICH IS
    POSITIVE)
  • THE LOSSES TO BUYERS AND SELLERS FROM A TAX EXCEED THE REVENUE
    RAISED BY THE GOVERNMENT
19
Q
  • A TAX ON A GOOD REDUCES THE WELFARE OF BUYERS AND SELLERS. THIS WELFARE
    LOSS USUALLY EXCEEDS THE REVENUE THE TAX RAISES FOR THE GOVT.
A
20
Q
  • THE FALL IN TOTAL SURPLUS (CONSUMER SURPLUS, PRODUCER SURPLUS, AND TAX
    REVENUE) IS CALLED THE DEADWEIGHT LOSS (DWL) OF THE TAX.
A
21
Q
  • A TAX HAS A DWL BECAUSE IT CAUSES CONSUMERS TO BUY LESS AND PRODUCERS
    TO SELL LESS, THUS SHRINKING THE MARKET BELOW THE LEVEL THAT MAXIMIZES
    TOTAL SURPLUS.
A
22
Q
  • THE PRICE ELASTICITIES OF DEMAND AND SUPPLY MEASURE HOW MUCH BUYERS
    AND SELLERS RESPOND TO PRICE CHANGES. THEREFORE, HIGHER ELASTICITIES
    IMPLY HIGHER DWLS.
A
23
Q
  • AN INCREASE IN THE SIZE OF A TAX CAUSES THE DWL TO RISE EVEN MORE.
A
24
Q
  • 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.
A
25
Q

how tax affects welfare
consumer surplus

A

*w/o tax
- A+B+C
*w/ tax
A
*change
-(B+C)

26
Q

how tax affects welfare
producer surplus

A

*w/o tax
- D+E+F
*w/ tax
F
*change
-(D+E)

27
Q

how tax affects welfare
tax revenue

A

*w/o tax
none
*w/ tax
B+D
*change
-(B+D)

28
Q

how tax affects welfare
total surplus

A

*w/o tax
A+B+C+D+E+F
*w/ tax
B+D
*change
-(C+E)

29
Q

consumer surplus

A
  • the diff between what consumers are willing to pay for a product and what they actually pay
  • imposed tax, the price paid by consumer increases
30
Q

producer surplus

A
  • the diff between what producers are willing to accept for a product and what they actually receive
  • imposed tax, price received by producers decreases
31
Q

total surplus

A
  • the combination of consumer and producer surplus in a market
  • tax imposed, relative changes in consumer and producer surplus