ECO2023 Ch 8 The costs of Taxation

Sofia pays Sam $50 to mow her lawn every week. When the government levies a mowing tax of $10 on Sam, he raises his price to $60. Sofia continues to hire him at the higher price. What is the change in producer surplus, change in consumer surplus, and deadweight loss?

$0, -$10, $0

Suppose a $3 per-unit tax is placed on this good. The per-unit burden of the tax on sellers is

$1

Suppose the government places a $5 per-unit tax on this good. The consumer surplus after this tax is

$10

The producer surplus without the tax is

$12,000

The total surplus without the tax is

$20,000

The amount of tax revenue received by the government is equal to

$245

Suppose Rebecca needs a dog sitter so that she can travel to her sister's wedding. Rebecca values dog sitting for the weekend at $200. Susan is willing to dog sit for Rebecca so long as she receives at least $175. Rebecca and Susan agree on a price of $185. Suppose the government imposes a tax of $30 on dog sitting. The tax has made Rebecca and Susan worse off by a total of

$25

Suppose the government imposes a $10 per unit tax on a good. After the tax goes into effect, consumer surplus is the area

A

If there is no tax placed on the product in this market, total surplus is the area

A + B + C + D + E + F.

If a tax is placed on the product in this market, total surplus is the area

A + B + C + D.

Suppose that the government imposes a tax of P3 - P1 The tax causes a reduction in consumer surplus that is represented by area

B+C

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.

If a tax is placed on the product in this market, producer surplus is the area

D.

Suppose the government imposes a $1 tax in each of the four markets represented by demand curves D1, D2, D3, and D4. The deadweight will be the smallest in the market represented by

D1

If a tax is placed on the product in this market, deadweight loss is the area

E + F.

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

False taxes collected from either the buyers or the sellers are equivalent. That is why economists simply use a tax wedge when analyzing a tax and avoid the issue altogether.

T/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.

False the loss in total surplus is the buyer's value minus the seller's cost or $20-$10=$10

Suppose the supply of oil is relatively inelastic. Would a tax on oil generate a large deadweight loss? Why or why not? Who would bear the burden of the tax, the buyer or the seller of oil? Why?

No. Because the supply of oil is highly inelastic, the quantity supplied is not responsive to a decrease in the price received by the seller. The seller would bear the burden of the tax for the same reason—supply of oil is highly inelastic.

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

True

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

True

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

True

T/F 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.

True

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

True

If T represents the size of the tax on a good and Q represents the quantity of the good that is sold, total tax revenue received by government can be expressed as

TxQ

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. all of the above.

all of the above.

Deadweight loss is greatest when

both supply and demand are relatively elastic.

The price elasticities of supply and demand affect

both the size of the deadweight loss from a tax and the tax incidence

A tax affects

buyers, sellers, and the government

A tax on gasoline is likely to

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

The reduction of a tax

could increase tax revenue if the tax had been extremely high.

Neither a shift of the demand curve nor a shift of the supply curve is shown on the figure. However, we know that, when the tax is imposed,

either the demand curve or the supply curve will shift

The Laffer curve illustrates that, in some circumstances, the government can reduce a tax on a good and increase the

government's tax revenue.

Deadweight loss measures the loss

in a market to buyers and sellers that is not offset by an increase in government revenue

When the government imposes taxes on buyers or sellers of a good, society

loses some of the benefits of market efficiency.

The benefit to sellers of participating in a market is measured by the

producer surplus

Suppose the federal government doubles the gasoline tax. The deadweight loss associated with the tax

quadruples

Suppose the government places a per-unit tax on a good. The smaller the price elasticities of demand and supply for the good, the

smaller the deadweight loss from the tax

When a tax is levied on buyers, the

tax creates a wedge between the price buyers effectively pay and the price sellers receive

Economists generally agree that the most important tax in the U.S. economy is the

tax on labor

A tax on a good has a deadweight loss if

the reduction in consumer and producer surplus is greater than the tax revenue

The size of the deadweight loss generated from a tax is affected by the

elasticities of both supply and demand.

If a tax is placed on the product in this market, consumer surplus is the area

A.

The vertical distance between points A and B represents a tax in the market. Before the tax is imposed, the equilibrium price is

$24, and the equilibrium quantity is 25

Suppose a tax of $20 per unit is imposed on a good. The supply curve is a typical upward-sloping straight line, and the demand curve is a typical downward-sloping straight line. The tax decreases consumer surplus by $18,000 and decreases producer surplus by $18,000. The deadweight loss of the tax is $4,000. The tax decreased the equilibrium quantity of the good from

2,000 to 1,600. When a $20 tax leads to a deadweight loss of $4,000, the tax decreased the quantity from 2,000 to 1,600. The base of the deadweight loss triangle is the decrease in quantity, so substituting the known values, $4,000 = ½ x base x $20. Thus, the decrease in quantity is 400 units. Computing the total loss of welfare and subtracting deadweight loss, $18,000 + $18,000 -$4,000 = $32,000, and dividing by the tax per unit, $32,000 / $20 = 1,600, gives the quantity after the tax.

If there is no tax placed on the product in this market, consumer surplus is the area

A + B + E.

Taxes are costly to market participants because they transfer resources from market participants to the government. alter incentives. distort market outcomes. All of the above are correct.

All of the above are correct.

Taxes are of interest to microeconomists because they consider how to balance equality and efficiency. microeconomists because they consider how best to design a tax system. macroeconomists because they consider how policymakers can use the tax system to stabilize economic activity. All of the above are correct.

All of the above are correct.

Anger over British taxes played a significant role in bringing about the

American Revolution.

T/F A tax will generate a greater deadweight loss if supply and demand are inelastic.

False a tax generates a greater deadweight loss when supply and demand are more elastic.

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.

Suppose the government imposes a $1 tax in each of the four markets represented by supply curves S1, S2, S3, and S4. The deadweight will be the largest in the market represented by

S4

What determines whether the deadweight loss from a tax is large or small?

The price elasticities of supply and demand, which measure how much the quantity supplied and quantity demanded respond to changes in the price.

Which of the following is true with regard to the burden of the tax in Exhibit 4? The buyers pay a larger portion of the tax because demand is more inelastic than supply. The buyers pay a larger portion of the tax because demand is more elastic than supply. The sellers pay a larger portion of the tax because supply is more elastic than demand. The sellers pay a larger portion of the tax because supply is more inelastic than demand.

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

Which of the following statements correctly describes the relationship between the size of the deadweight loss and the amount of tax revenue as the size of a tax increases from a small tax to a medium tax and finally to a large tax? a. Both the size of the deadweight loss and tax revenue decrease. b. The size of the deadweight loss increases, but the tax revenue first increases, then decreases. c. The size of the deadweight loss increases, but the tax revenue decreases. d. Both the size of the deadweight loss and tax revenue increase

The size of the deadweight loss increases, but the tax revenue first increases, then decreases

In which of the following cases is it most likely that an increase in the size of a tax will increase tax revenue? The size of the tax before the increase was medium relative to the size of the market. The size of the tax before the increase was small relative to the size of the market. An increase in the size of a tax will always increase tax revenue. The size of the tax before the increase was large relative to the size of the market.

The size of the tax before the increase was small relative to the size of the market. When the size of the tax is small, an increase in the size of the tax will likely cause a movement along the upward-sloping section of the Laffer curve and result in an increase in tax revenue.

Daniel Patrick Moynihan, the late senator from New York, once introduced a bill that would levy a 10,000 percent tax on certain hollow-tipped bullets. Why might Senator Moynihan have proposed it?

To discourage the use of hollow-tipped bullets Senator Moynihan's goal was probably to discourage the use of hollow-tipped bullets. In this case, the tax could be as effective as an outright ban.

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

True

T/F A larger tax always generates a larger deadweight loss.

True

Suppose that the government imposes a tax on heating oil. True or False: The deadweight loss from this tax would likely be larger in the fifth year after it is imposed than in the first year as demand for heating oil become more elastic.

True The deadweight loss from a tax on heating oil is likely to be greater in the fifth year after it is imposed than in the first year. In the first year, the elasticity of demand is fairly low, as people who own oil furnaces are not likely to get rid of them right away. But over time they may switch to other energy sources, and people buying new furnaces for their homes will more likely choose gas or electric, so a tax will have a greater impact on quantity. Thus, the deadweight loss of the tax will become larger over time.

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

caused a deadweight loss.

Refer to the Figure. The imposition of the tax causes the price received by sellers to

decrease by $2. Before the tax, the price received by sellers was $8. After the tax, the price received by sellers is $6, a decrease of $2 from the pre-tax price.

Refer to the Figure. If the economy is at point N on the curve, then a decrease in the tax rate will

decrease the deadweight loss of the tax and increase tax revenue. As the size of the tax decreases, deadweight loss decreases. On the downward-sloping portion of the Laffer curve, as the tax rate decreases, tax revenue increases

When a tax on a good starts small and is gradually increased, tax revenue will rise. fall. first rise and then fall. first fall and then rise. do none of the above.

first rise and then fall.

If the economy is at point A on the curve, then a small increase in the tax rate will

increase the deadweight loss of the tax and increase tax revenue

Eggs have a supply curve that is linear and upward-sloping and a demand curve that is linear and downward-sloping. If a 2 cent per egg tax is increased to 3 cents, the deadweight loss of the tax

increases by more than 50 percent.

Suppose that the government imposes a tax on heating oil. The tax revenue collected from a tax on heating oil is likely to be (?) in the first year after it is imposed than in the fifth year.

larger The tax revenue is likely to be higher in the first year after it is imposed than in the fifth year. In the first year, demand is more inelastic, so the quantity does not decline as much and tax revenue is relatively high. As time passes and more people substitute away from oil, the quantity sold declines, and so does tax revenue.

Suppose a tax of $1 per unit is imposed on a good. The more elastic the supply of the good, other things equal, the

larger is the deadweight loss of the tax.

Suppose policymakers agree to increase the size of the tax on gasoline. As a result, we can conclude that the tax revenue from the tax on gasoline

may increase, decrease, or remain the same. As the size of the tax grows, tax revenue first rises and then falls as illustrated by the Laffer curve.

When a tax is imposed on the sellers of a good, the

supply curve shifts upward by the amount of the tax

When motorcycles are taxed and sellers of motorcycles are required to pay the tax to the government,

the quantity of motorcycles bought and sold in the market is reduced

Diana is a personal trainer whose client Charles pays $80 per hour-long session. Charles values this service at $100 per hour, while the opportunity cost of Diana's time is $75 per hour. The government places a tax of $10 per hour on personal trainers. Before the tax, what is the total surplus?

$25

Suppose the government places a $5 per-unit tax on this good. The per-unit burden of the tax on sellers is

$3

The loss of producer surplus as a result of the tax is

$3

Tom walks Bethany's dog once a day for $50 per week. Bethany values this service at $60 per week, while the opportunity cost of Tom's time is $30 per week. The government places a tax of $35 per week on dog walkers. After the tax, what is the loss in total surplus?

$30

Dominic plows Soraya's driveway for $85. Dominic's opportunity cost of plowing Soraya's driveway is $55, and Soraya's willingness to pay Dominic to plow her driveway is $100. If Soraya hires Dominic to mow her lawn, Soraya's consumer surplus is

$15. Consumer surplus is the amount the buyer is willing to pay minus the price she must pay, so Soraya's consumer surplus is $100 - $85 = $15.

For widgets, the supply curve is the typical upward-sloping straight line, and the demand curve is the typical downward-sloping straight line. A tax of $15 per unit is imposed on widgets. The tax reduces the equilibrium quantity in the market by 300 units. The deadweight loss from the tax is

$2,250

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.

If a tax is placed on the product in this market, tax revenue paid by the buyers is the area

B.

If there is no tax placed on the product in this market, producer surplus is the area

C + D + F.

If a tax is placed on the product in this market, tax revenue paid by the sellers is the area

C.

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

Deadweight loss increases continuously because as a tax increases, the distortion in prices caused by the tax causes the market to shrink continuously. Thus, we fail to produce more and more units where the benefits to buyers exceed the costs to sellers.

After economics class one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. True or False: A tax on food leads to larger deadweight loss than a tax on goods with more elastic demand. True or False: Taxing food is a good way to raise revenue from an equality point of view because everyone consumes food.

False/False Because the demand for food is inelastic, a tax on food leads to relatively little deadweight loss; thus, taxing food is a more efficient way of raising revenue than taxing other things. However, a tax on food is not a good way to raise revenue from an equality point of view because poorer people spend a higher proportion of their income on food. The tax would hit them harder than it would hit wealthier people.

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 prices to buyers and sellers causes the market to shrink and large taxes are collected on a small number of units exchanged.

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.

Suppose the government imposes a $10 per unit tax on a good. After the tax goes into effect, producer surplus is the area

J

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

Laffer curve.

You are watching the local news report on television with your roommate. The news anchor reports that the state budget has a deficit of $100 million. Because the state currently collects exactly $100 million from its 5 percent sales tax, your roommate says, "I can tell them how to fix their deficit. They should simply double the sales tax to 10 percent. That will double their tax revenue from $100 million to $200 million and provide the needed $100 million." Will doubling the sales tax affect the tax revenue and the deadweight loss in all markets to the same degree? Explain.

No. Some markets may have extremely elastic supply-and-demand curves. In these markets, an increase in a tax causes market participants to leave the market, and little revenue is generated from the tax increase, but deadweight loss increases a great deal. Other markets may have inelastic supply-and-demand curves. In these markets, an increase in a tax fails to cause market participants to leave the market and a great deal of additional tax revenue is generated with little increase in deadweight loss.

When a tax is placed on a good, does the government collect revenue equal to the loss in total surplus due to the tax? Why or why not?

No. The tax distorts prices 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 the deadweight loss.

The amount of tax revenue received by the government is equal to the area

P3ACP1

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

There would be a greater deadweight loss in the long run. This is because both demand and supply tend to be more elastic in the long run as consumers and producers are able to substitute away from this market when prices move in an adverse direction. The more a market shrinks from a tax, the greater the deadweight loss.

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

True

T/F The government can raise revenue by taxing the sellers without creating deadweight loss when the demand for the goods being taxed is perfectly inelastic.

True When the demand for a good is perfectly inelastic, a tax on sellers will only affect the market price and create a tax wedge without any effect on the quantity. Therefore, the government can raise revenue without creating deadweight loss in this case.

Dominic plows Soraya's driveway for $85. Dominic's opportunity cost of plowing Soraya's driveway is $55, and Soraya's willingness to pay Dominic to plow her driveway is $100. If Soraya hires Dominic to plow her driveway, Dominic's producer surplus is

$30. Producer surplus is the price the seller receives minus the opportunity cost of supplying the good or service, so Dominic's producer surplus is $85 - $55 = $30.

The tax revenue that the government collects equals

(P3-P1)*Q1

Suppose a tax of $3 per unit is imposed on a good. The supply curve is a typical upward-sloping straight line, and the demand curve is a typical downward-sloping straight line. The tax decreases consumer surplus by $3,900 and decreases producer surplus by $3,000. The tax generates tax revenue of $6,000. The tax decreased the equilibrium quantity of the good from

2,600 to 2,000

T/F A tax that raises no revenue for the government cannot have any deadweight loss.

False An example is the case of a 100% tax imposed on sellers. With a 100% tax on their sales of the good, sellers will not supply any of the good, so the tax will raise no revenue. Yet the tax has a large deadweight loss because it reduces the quantity sold to zero.

Daniel Patrick Moynihan, the late senator from New York, once introduced a bill that would levy a 10,000 percent tax on certain hollow-tipped bullets. True or False: This tax would generate a lot of tax revenue because of its high rate.

False This tax has such a high rate that it is not likely to raise much revenue. Because of the high tax rate, the equilibrium quantity in the market is likely to be at or near zero.

T/F A larger tax always generates more tax revenue.

False as a tax increases, revenue first rises and then falls as the tax shrinks the market to a point where all trades are eliminated and tax revenue is zero.

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

False deadweight loss is the reduction in total surplus that results from a tax.

T/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.

False the loss of producer and consumer surplus exceeds the revenue from the tax. The difference is deadweight loss.

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

False the more elastic the demand curve, the greater the deadweight loss, and the demand for cigarettes (a necessity) should be more inelastic than the demand for luxury boats (a luxury).

You are watching the local news report on television with your roommate. The news anchor reports that the state budget has a deficit of $100 million. Because the state currently collects exactly $100 million from its 5 percent sales tax, your roommate says, "I can tell them how to fix their deficit. They should simply double the sales tax to 10 percent. That will double their tax revenue from $100 million to $200 million and provide the needed $100 million." Is it true that doubling a tax will always double tax revenue? Why or why not?

No. Usually an increase in a tax will reduce the size of the market because the tax will increase the price to buyers, causing them to reduce their quantity demanded and will decrease the price to sellers, causing them to reduce their quantity supplied. Therefore, when taxes double, the government collects twice as much per unit on many fewer units, so tax revenue will increase by less than double and could, in some extreme cases, even go down.

Suppose the government imposes a $1 tax in each of the four markets represented by supply curves S1, S2, S3, and S4. The deadweight will be the smallest in the market represented by

S1

Suppose Rachel values having her house painted at $1,000. The cost for Paul to paint her house is $700. What is the value of the total surplus or 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 = $300. Any tax larger than $300. Deadweight loss would be $300. A tax that is greater than the potential gains from trade will eliminate trade and create a deadweight loss equal to the lost gains from trade.

Which of the following would likely cause the greatest deadweight loss? a tax on cigarettes a tax on salt a tax on cruise line tickets a tax on gasoline

a tax on cruise line tickets

Suppose that the government imposes a tax on corn used in the production of ethanol. The deadweight loss from this tax will likely be greater if

buyers and sellers have two years to adjust to the tax than if buyers and sellers have two months to adjust to the tax, because demand and supply will be more elastic. Both demand and supply are more elastic with a longer time horizon to adjust to a price change. The greater the elasticities of demand and supply, the greater the deadweight loss of a tax.

The imposition of the tax causes the price received by sellers to

decrease from $600 to $300

When a country is on the upward-sloping side of the Laffer curve, an increase in the tax rate will

increase tax revenue and increase the deadweight loss. When a country is on the upward-sloping side of the Laffer curve, an increase in the tax rate will increase tax revenue because as the size of the tax increases, revenue first increases, then decreases. As the tax rate increases, deadweight loss continually increases.

If the economy is at point B on the curve, then an increase in the tax rate will

increase the deadweight loss of the tax and decrease tax revenue

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

increases by a factor of four.

Peanut butter has an upward-sloping supply curve and a downward-sloping demand curve. If a 10 cent per pound tax is increased to 15 cents, the government's tax revenue

increases by less than 50 percent and may even decline.

After economics class one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. Taxing food is (?) efficient than taxing other things with more elastic demand. A tax on food is (?) equal than a tax on other things with higher demand elasticity.

more;less Because the demand for food is inelastic, a tax on food leads to relatively little deadweight loss; thus, taxing food is a more efficient way of raising revenue than taxing other things. However, a tax on food is not a good way to raise revenue from an equality point of view because poorer people spend a higher proportion of their income on food. The tax would hit them harder than it would hit wealthier people.

Ronald Reagan believed that reducing income tax rates would

raise economic well-being and perhaps even tax revenue

Which of the following is not an example of the type of tax that economists generally agree is the most important tax in the U.S. economy? Medicare tax sales tax federal income tax Social Security tax

sales tax Economists generally agree that taxes on labor are the most important taxes in the U.S. economy. The Medicare tax, the Social Security tax, and the federal income tax are all examples of the tax on labor.

Suppose the supply of diamonds is relatively inelastic. A tax on diamonds would generate a

small deadweight loss and the burden of the tax would fall on the seller of diamonds.

If a policymaker wants to raise revenue by taxing goods while minimizing the deadweight losses, he should look for goods with (?) elasticities of demand and (?) elasticities of supply.

small, small

One result of a tax, regardless of whether the tax is placed on the buyers or the sellers, is that the

tax reduces the welfare of both buyers and sellers