Excise Tax : Analysis of a $1/unit excise tax

1. Excise Tax: Analysis of a $1/unit excise tax P S Pe D 0 Qe • Q

2. Excise Tax: Analysis of a $1/unit excise tax Cigarettes Here is the market for cigarettes in equilibrium. What will happen if a 1$/pack tax is enacted? P S Pe D 0 Qe • Q

3. Excise Tax: Analysis of a $1/unit excise tax Cigarettes Here is the market for cigarettes in equilibrium. What will happen if a 1$/pack tax is enacted? P S What will happen to Demand as a result of the tax? Pe NOTHING HAPPENS TO DEMAND. Excise taxes work like production costs and affect SUPPLY. D 0 Qe • Q

4. Excise Tax: Analysis of a $1/unit excise tax St Cigarettes Here is the market for cigarettes in equilibrium. What will happen if a 1$/pack tax is enacted? P S $7 What will happen to Supply as a result of the tax? $6 Supply will move up (and to the left). It will move UP by the amount of the tax. D 0 Qe • Q

5. Excise Tax: Analysis of a $1/unit excise tax St Cigarettes Notice though, that the PRICE does not go up by the full amount of the tax. This shows that the tax burden is shared by consumers and producers. Quantity also goes down, as with any decrease in supply. P S $7 Pt $6 D 0 Qe Qt • Q

6. Excise Tax: Analysis of a $1/unit excise tax OK, let’s assume that this is split right down the middle and the new price is $6.50. How much are consumers now paying for cigarettes? $6.50 How much are producers actually getting for cigarettes? $5.50 (They have to pay the $1 tax.) Compared to before, each is paying exactly half of the $1.00 tax. St Cigarettes P S $6.50 $6 $5.50 D 0 Qe Qt • Q

7. Excise Tax: Analysis of a $1/unit excise tax Let’s look at the areas of consumer surplus, producer surplus, and deadweight loss after the tax. To do that, we remove the new Supply curve (St). What happened to the rest of it? St Cigarettes P S $6.50 $6 $5.50 D 0 Qe Qt • Q

8. Excise Tax: Analysis of a $1/unit excise tax Some of it goes to the government in the form of the tax. What about the last part? Cigarettes P S $6.50 Tax Revenue $6 Tax Revenue $5.50 D 0 Qe Qt • Q

9. Excise Tax: Analysis of a $1/unit excise tax Some of it goes to the government in the form of the tax. What about the last part? You guessed it: Deadweight Loss Cigarettes P S $6.50 Tax Revenue $6 Tax Revenue $5.50 D 0 Qe Qt • Q

10. Excise Tax: Analysis of a $1/unit excise tax Let’s put some numbers in here and do some calculations: Original Consumer Surplus? New Consumer Surplus? Original Producer Surplus? New Producer Surplus? Tax Revenue? Deadweight Loss? Cigarettes $10 P S $6.50 Tax Revenue $6 Tax Revenue $5.50 $2 D 0 90 Qe 100 Qt • Q

11. Excise Tax: Analysis of a $1/unit excise tax St Cigarettes When demand is very inelastic, producers can pass on more of the tax to consumers. P S $7 $6.80 Price for cigarettes is now $6.80. Consumers pay 80% of the tax. Producers only pay 20% of the tax. $6 $5.80 D 0 Qt Qe • Q