AP Econ Chapter 8

When a tax on a good starts small and is gradually increased, tax revenue will

First rise and then fall

As a tax on a good increases, what happens to tax revenue? Why?

First tax revenue increases. At some point tax revenue decreases as the distortion in price to buyers and sellers causes the market to shrink and large taxes are collected on a small number of units exchanged.

The graph that shows the relationship between the size of a tax and the tax revenue collected by the government is known as

Laffer curvd

What are the three costs of taxation?

Tax payment itself Deadweight loss Administrative burdens

Tax wedge

The difference between what the buyer pays and the seller receives when a tax is placed in a market

Consumption tax

The more of a good or service you use, the more you have to pay for it

How do you find the size of a tax?

The price buyers pay minus the price sellers receive

Deadweight loss

The reduction in total surplus that results from a tax

Which of the following would likely cause the greatest deadweight loss?

a tax on cruise line tickets

Laffer curve

A graph showing the relationship between the size of a tax and the tax revenue collected

Since the supply of unimproved land is relatively inelastic, a tax on unimproved land would generate

A small deadweight loss and the burden of the tax would fall on the landlord

Why does a tax generally produce a deadweight loss?

A tax raises the price buyers pay and lowers the price sellers receive. This price distortion reduces the quantity demanded and supplied so we fail to produce and consume units where the benefits to the buyers exceed the costs to the sellers.

A tax on gasoline is likely to

Cause a greater deadweight loss in the long run when compared to the short run

When a tax distorts incentives to buyers and sellers so that fewer goods are produced and sold than otherwise, the tax has

Caused a deadweight loss

Why does a tax reduce consumer surplus?

Consumer surplus is what the buyer is willing to pay for a good minus what the buyer actually pays, and a tax raises the price the buyer actually pays.

As a tax on a good increases, what happens to the deadweight loss from the tax? Why?

Deadweight loss continuously increases because as a tax increases, the distortion in prices caused by the tax causes the market to shrink continuously.

What happens to deadweight loss as the tax increases?

Deadweight loss increases twice as fast as the tax.

What are the two determinants of deadweight loss?

Elasticity and size of the tax

Bill Clinton

Elected after George Bush broke his promise of no new taxes Increased income tax on high income tax payers

A larger tax always generates more tax revenue. T or F?

F

A tax collected from buyers generates a smaller deadweight loss than a tax collected from sellers. T or F?

F

A tax on cigarettes would likely generate a larger deadweight loss than a tax on luxury boats. T or F?

F

A tax will generate a greater deadweight loss of supply and demand are inelastic. T or F?

F

Deadweight loss is the reduction in consumer surplus that results from a tax. T or F?

F

If John values having his hair cut at $20 and Mary's cost of providing the haircut is $10, any tax on haircuts larger than $10 will eliminate the gains from trade and cause a $20 loss of total surplus. T or F?

F

When a tax is placed on a good, the revenue the government collects is exactly equal to the loss of consumer and producer surplus from the tax. T or F?

F

Under what conditions would a tax fail to produce a deadweight loss?

If either supply or demand were perfectly inelastic (insensitive to a change in price), then a tax would fail to reduce the quantity exchanged and the market would not shrink.

Would you expect a tax on gasoline to have a greater deadweight loss in the short or long run?

Long run. Supply and demand are more elastic in the long run and the more elastic, the higher the deadweight loss.

Would a tax on unimproved land generate a large deadweight loss? Why? Who would bear the burden of the tax, the renter or landlord?

No. The supply of unimproved land is inelastic, so there would be little to no deadweight loss. The landlord would bear the burden because supply is the less elastic side.

When a tax is placed on a good, does the government collect revenue equal to the loss in total surplus due to the tax?

No. The tax distorts the price to buyers and sellers and causes them to reduce their quantities demanded and supplied. Taxes are collected only on the units sold after the tax is imposed. Those units that are no longer produced and sold generate no tax revenue, but those units would have added to total surplus because they were valued by buyers in excess of their cost to sellers. The reduction in total surplus is deadweight loss.

"Taxes are the price we pay for a civilized society"

Oliver Wendell Holmes

Ronald Reagan

Platform of large cuts in personal income taxes Income tax rates fell from 70 to 28 percent Tax revenue fell by 9 percent

Why does a tax reduce producer surplus?

Producer surplus is the amount the seller receives for a good minus the seller's cost, and a tax reduces what the seller receives for a good.

A deadweight loss results when a tax causes a market participant to fail to produce and consume units on which the benefits to the buyers exceed the costs to sellers. T or F?

T

A larger tax always generates a larger deadweight loss. T or F?

T

A tax causes a deadweight loss because it eliminates some of the potential gains from trade. T or F?

T

If a tax is doubled, the deadweight loss from the tax more than doubles. T or F!

T

If a tax is placed on a good and it reduces the quantity sold, there must be a deadweight loss from the tax. T or F?

T

If a tax is placed on a good in a market where supply is perfectly inelastic, there is no deadweight loss and the sellers bear the entire burden of the tax. T or F?

T

If an income tax rate is high enough, a reduction in the tax rate could increase tax revenue. T or F?

T

In general, a tax raises the price the buyers pay and lowers the price sellers receive, and reduces the quantity sold. T or F?

T

Which of the following is true with regard to the burden of the tax in Exhibit 4?

The sellers pay a larger portion of the tax because supply is more inelastic than demand.

How do you find tax revenue?

The size of the tax times the quantity sold

Administrative burden

Time, record keeping and money spent when you have to file your taxes

Suppose Rachel values having had house painted at $1,000. The cost for Paul to paint her house is $700. What is the value of the total surplus of the gains from trade on this transaction? What is the size of the tax that would eliminate this trade? What is the deadweight loss from this tax? What generalization can you make from this exercise?

Total surplus = buyers willingness to pay minus sellers cost = $1,000 - $700 = $300 Any tax larger than $300. Deadweight loss would be $300. A tax that is greater than the potential gain from trade will eliminate trade and create a deadweight loss equal to the lost gains from trade.

Income tax evasion

When you earn income but don't pay taxes on it

Taxes on labor income tend to encourage

Workers to work fewer hours Second earners to stay home The elderly to retire early The unscrupulous to enter the underground economy

Deadweight loss is greatest when

both supply and demand are relatively elastic

The reduction of a tax

could increase tax revenue if the tax had been extremely high

If a tax on a good is doubled, the deadweight loss from a tax

increases by a factor of four