CH 8 Application: The Costs Of Taxation

What happens to consumer and producer surplus when the sale of a good is taxed?

A tax on a good reduces the welfare of buyers and sellers of the good , and the reduction in consumer and producer surplus usually exceeds the revenue raised by the government.

Why do the elasticities of supply and demand have this effect?

Because the elasticities of supply and demand measure how much market participants respond to market conditions, larger elasticities imply larger DW losses. Smaller elasticities imply smaller DW losses.

Wha happend to the DW loss and tax revenue when a tax is increased?

As a tax grows larger, it distorts incentives more, and its DW loss grows larger. Because a tax reduces the size of the market, however, tax revenue does not continually increase. It first rises with the size of a tax, but if the tax gets large enough, tax revenue starts to fall.

Why do experts disagree about whether labor taxes have small or large deadweight losses? (QUESTION pg 165)

Economists disagree about these issues in part because there is no consensus about eh size of the relevant elasticities. Also the general lesson is that a change in tax revenue from a tax change depends on how the tax change affects peoples behavior.

How do the elasticities of supply and demand affect the DW losses of a tax?

Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less, and these changes in behavior shrink the size of the market below the level that maximizes total surplus.

How does the change in consumer and producer surplus compare to the tax revenue?

The fall in total surplus- the sum of consumer surplus, producer surplus, and tax revenue- is called the deadweight loss

Deadweight loss

the fall in total surplus that results from a market distortion, such as a tax.