Chapter 6

Tax Burden

Falls more heavily on side of market that is less elastic. Small elasticity of demand means buyers do not have good alternatives to consuming this good. Small elasticity of supply means sellers do not have good alternatives to producing this.

Tax Levied on Sellers

Immediate impact on sellers - shift in supply, as supply curve shifts left. Higher equilibrium price, lower equilibrium quantity. The tax reduces the size of the market. Discourages market activity Buyers and sellers share the burden of the tax. Buyers pay more and are therefore worse off. Sellers receive less and are worse off.

Tax Levied on Buyers of a Good

Initial impact on the demand, as demand curve shifts left. Lower equilibrium price and equilibrium quantity. The tax reduces the size of the market. Buyers and sellers share the burden of the tax. Sellers get a lower price. Buyers pay a lower market price.

Price Ceiling

Legal maximum on the price at which a good can be sold.

Price Floor

Legal minimum on the price at which a good can be sold.

Tax Incidence

Manner in which the burden of a tax is shared among participants in a market.

Evaluating Price Controls

Markets are usually a good way to organize economic activity. Governments can sometimes improve market outcomes by using price controls because of unfair market outcome and to help the poor. Often, this hurts those they want to help. Substitutes to this: rent subsidies and wage subsidies.

How Price Ceilings Affect Market Outcomes

Not binding (above equilibrium price, no effect on the price or quantity sold). Binding constraint (below equilibrium price, shortage, sellers must ration the scarce goods).

How Price Floors Affect Market Outcomes

Not binding (below equilibrium price, no effect on the market). Binding (above equilibrium price, surplus, some sellers are unable to sell what they want).

Relatively Inelastic Supply and Very Elastic Demand Means...

Sellers have most of the tax burden, buyers have small burden.

Very Elastic Supply and Relatively Inelastic Demand Means...

Sellers have small burden of tax, buyers have most burden.

Government Use Taxes

To raise revenue for public projects.

Taxes Levied on Sellers and Taxes Levied on Buyers are Equivalent

Wedge b/w price that buyers pay and price sellers receive are the same regardless of tax levied on buyers or sellers. It shifts the relative position of the supply and demand curves. Buyers and sellers share the tax burden.