Chapter 8 Questions for Review
Why do experts disagree about whether labor taxes have small or large deadweight losses?
Experts disagree about whether labor taxes have small or large deadweight losses because they have different views about the elasticity of labor supply. Some believe that labor supply is inelastic, so a tax on labor has a small deadweight loss. But others think that workers can adjust their hours worked in various ways, so labor supply is elastic, and thus a tax on labor has a large deadweight loss
What happens to the deadweight loss and tax revenue when a tax is increased? How does the change in consumer and producer surplus compare to the tax revenue?
The deadweight loss of a tax rises more than proportionally as the tax rises. Tax revenue, however, may increase initially as a tax rises, but as the tax rises further, revenue eventually declines The fall in total surplus- the sum of consumer surplus, producer surplus, and tax revenue- is called the deadweight loss
How do the elasticities of supply and demand affect the deadweight losses of a tax? Why do they have this effect?
The greater the elasticities of demand and supply, the greater the deadweight loss of a tax. Because elasticity measures the response of quantity to a change in price, higher elasticity means the tax induces a greater reduction in quantity, and therefore a greater distortion to the market
What happens to consumer and producer surplus when the sale of a good is taxed?
When the sale of a good is taxed, both consumer surplus and producer surplus decline. The decline in consumer surplus and producer surplus exceeds the amount of government revenue that is raised, so society's total surplus declines. The tax distorts the incentives of both buyers and sellers, so resources are allocated inefficiently
Draw a supply-and-demand diagram with a tax on the sale of a good. Show the deadweight loss. Show the tax revenue.
Without a tax, the equilibrium would be Q1, the equilibrium price would be P1, consumer surplus would be A + B + C, and producer surplus would be D + E + F. The imposition of a tax places a wedge between the price buyers pay, Pb, and the price sellers receive, Ps, where Pb=Ps + tax. The quantity sold declines to Q2. Now consumer surplus is A, producer surplus is F, and government revenue is B + D. The deadweight loss of the tax is C + E because that area is lost due to the decline in quantity from Q1 to Q2.