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Module 7

Analyzing the Economic Impact of Taxes. Module 7. Objectives. Use demand and supply graphs to analyze the economic impact of taxes. 2. Use demand and supply graphs to analyze the economic impact of taxes. Compare the pre-tax market outcomes and the post-tax market outcomes. Objectives. 3.

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Module 7

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  1. Analyzing the Economic Impact of Taxes Module 7

  2. Objectives Use demand and supply graphs to analyze the economic impact of taxes. 2

  3. Use demand and supply graphs to analyze the economic impact of taxes. Compare the pre-tax market outcomes and the post-tax market outcomes. Objectives 3

  4. Use demand and supply graphs to analyze the economic impact of taxes. Compare the pre-tax market outcomes and the post-tax market outcomes. What happens to consumer surplus following the tax? Objectives 4

  5. Use demand and supply graphs to analyze the economic impact of taxes. Compare the pre-tax market outcomes and the post-tax market outcomes. What happens to consumer surplus following the tax? What happens to producer surplus when a tax is imposed on a good? Objectives 5

  6. Use demand and supply graphs to analyze the economic impact of taxes. Compare the pre-tax market outcomes and the post-tax market outcomes. What happens to consumer surplus following the tax? What happens to producer surplus when a tax is imposed on a good? Identify the deadweight loss created by a tax. Objectives 6

  7. Use demand and supply graphs to analyze the economic impact of taxes. Compare the pre-tax market outcomes and the post-tax market outcomes. What happens to consumer surplus following the tax? What happens to producer surplus when a tax is imposed on a good? Identify the deadweight loss created by a tax. Determine if a tax is efficient. Objectives 7

  8. Some Terminology • A tax can be levied on a buyer or a seller. This means that the government collects the tax directly from the buyer or the seller. 8

  9. Some Terminology • A tax can be levied on a buyer or a seller. This means that the government collects the tax directly from the buyer or the seller. • Tax “burden”or “incidence”, on the other hand, refers to who actually bears the tax. 9

  10. Some Terminology • A tax can be levied on a buyer or a seller. This means that the government collects the tax directly from the buyer or the seller. • Tax “burden”or “incidence”, on the other hand, refers to who actually bears the tax. • Whether a tax is levied on consumers or producers does not affect the tax incidence. 10

  11. The end results of a tax are: • Consumers typically pay a higher price for the product and there will be a loss of consumer surplus. 11

  12. The end results of a tax are: • Consumers typically pay a higher price for the product and there will be a loss of consumer surplus. • The net price received by producers falls and there will be a loss of producer surplus. The net price means the price after paying the tax. Another way of describing “net price” is the revenue net of tax for each unit sold. 12

  13. The end results of a tax are: • Consumers typically pay a higher price for the product and there will be a loss of consumer surplus. • The net price received by producers falls and there will be a loss of producer surplus. The net price means the price after paying the tax. Another way of describing “net price” is the revenue net of tax for each unit sold. • There is a deadweight loss because of the tax. This deadweight loss is also called the excess burden of the tax. 13

  14. Who actually bears the tax? 14

  15. Who actually bears the tax? The tax burden varies depending on how responsive producers and consumers are to the price change caused by the tax. 15

  16. Suppose the tax is levied on the sellerof a product. This simply means that the government collects the tax directly from the seller. 16

  17. Suppose the tax is levied on the sellerof a product. This simply means that the government collects the tax directly from the seller. • Graphically, levying a tax on the seller is shown by a vertical or upward shift of the supply curve by the full amount of the tax. 17

  18. Suppose the tax is levied on the sellerof a product. This simply means that the government collects the tax directly from the seller. • Graphically, levying a tax on the seller is shown by a vertical or upward shift of the supply curve by the full amount of the tax. 18

  19. In order to determine how the burden of the tax is shared, we need to trace its effects as it works through the market. 19

  20. In order to determine how the burden of the tax is shared, we need to trace its effects as it works through the market. Let’s see what happens when we add a demand curve to the graph. 20

  21. In order to determine how the burden of the tax is shared, we need to trace its effects as it works through the market. Let’s see what happens when we add a demand curve to the graph. The price paid by consumers has gone up from $12 to Pc but it has not gone up by the full amount of the tax. It has gone up by less than $4. 21

  22. Objective: Compare the pre-tax market outcomes and the post-tax market outcomes Example: Suppose the government imposes a unit tax of $4 in the market for wines. 22

  23. Objective: Compare the pre-tax market outcomes and the post-tax market outcomes Example: Suppose the government imposes a unit tax Of $4 in the market for wines. Let S0= supply curve before the imposition of the tax. 23

  24. Objective: Compare the pre-tax market outcomes and the post-tax market outcomes Example: Suppose the government imposes a unit tax Of $4 in the market for wines. Let S0= supply curve before the imposition of the tax. 24

  25. Objective: Compare the pre-tax market outcomes and the post-tax market outcomes • And now a $4 unit tax is levied on the seller. This is shown by an upwards shift of the supply curve. The supply curve shifts up by the full amount of the tax. The distance ef = cs= $4 25

  26. Objective: Compare the pre-tax market outcomes and the post-tax market outcomes The price increase to the buyer as a result of the tax The fall in revenue received by the seller for each unit sold. The total tax revenue collected by the government. Tax revenue =unit tax  quantity sold 26

  27. The effects of a tax: a summary • Following the imposition of the tax, • The supply curve shifts up by the full amount of the tax. 27

  28. The effects of a tax: a summary • Following the imposition of the tax, • The supply curve shifts up by the full amount of the tax. • The price paid by consumers has increased. 28

  29. The effects of a tax: a summary • Following the imposition of the tax, • The supply curve shifts up by the full amount of the tax. • The price paid by consumers has increased. • The net price received by producers has decreased. 29

  30. The effects of a tax: a summary • Following the imposition of the tax, • The supply curve shifts up by the full amount of the tax. • The price paid by consumers has increased. • The net price received by producers has decreased. • The quantity traded has decreased. 30

  31. The effects of a tax: a summary • Following the imposition of the tax, • The supply curve shifts up by the full amount of the tax. • The price paid by consumers has increased. • The net price received by producers has decreased. • The quantity traded has decreased. • The government collects tax revenue (a benefit). 31

  32. What happens to consumer surplus when a unit tax is imposed on a good? 32

  33. What happens to consumer surplus when a unit tax is imposed on a good? 33

  34. What happens to consumer surplus when a unit tax is imposed on a good? Loss in Consumer Surplus = U + V + W - U = V + W 34

  35. The consumer surplus loss when a unit tax is imposed Loss in Consumer Surplus = V + W = $1,920 - $1,080 = $840 35

  36. The consumer surplus loss when a unit tax is imposed Loss in Consumer Surplus = V + W = $1,920 - $1,080 = $840 OR calculate the loss in consumer surplus by adding the area of the rectangleV and the area of the triangle W 36

  37. The consumer surplus loss when a unit tax is imposed Loss in Consumer Surplus = V + W = $1,920 - $1,080 = $840 OR calculate the loss in consumer surplus by adding the area of the rectangleV and the area of the triangle W Area of rectangleV= 2 x 360 = $720 37

  38. The consumer surplus loss when a unit tax is imposed Loss in Consumer Surplus = V + W = $1,920 - $1,080 = $840 OR calculate the loss in consumer surplus by adding the area of the rectangleV and the area of the triangle W Area of rectangleV= 2 x 360 = $720 Area of triangle W= ½ x 120 x 2 =$120 38

  39. The consumer surplus loss when a unit tax is imposed Loss in Consumer Surplus = V + W = $1,920 - $1,080 = $840 OR calculate the loss in consumer surplus by adding the area of the rectangleV and the area of the triangle W Area of rectangleV= 2 x 360 = $720 Area of triangle W= ½ x 120 x 2 =$120 Therefore, loss in Consumer Surplus= $840 39

  40. What happens to producer surplus when a unit tax is imposed on a good? 40

  41. What happens to producer surplus when a unit tax is imposed on a good? This is the net price to the seller. The buyer pays $14 but the seller cannot keep this entire amount. $4 must be given to the government 41

  42. What happens to producer surplus when a unit tax is imposed on a good? This is the net price to the seller. The buyer pays $14 but the seller cannot keep this entire amount. $4 must be given to the government Loss in Producer Surplus = X + Y +Z – Z = X + Y 42

  43. The producer surplus loss when a unit tax is imposed Loss in Producer Surplus = X + Y = $1,920 - $1,080 = $840 43

  44. The producer surplus loss when a unit tax is imposed Loss in Producer Surplus = X + Y = $1,920 - $1,080 = $840 OR calculate the loss in producer surplus by adding the area of the rectangleX and the area of the triangle Y 44

  45. The producer surplus loss when a unit tax is imposed Loss in Producer Surplus = X + Y = $1,920 - $1,080 = $840 OR calculate the loss in producer surplus by adding the area of the rectangleX and the area of the triangle Y Area of rectangleX= 2  360 = $720 45

  46. The producer surplus loss when a unit tax is imposed Loss in Producer Surplus = X + Y = $1,920 - $1,080 = $840 OR calculate the loss in producer surplus by adding the area of the rectangleX and the area of the triangle Y Area of rectangleX= 2  360 = $720 Area of triangle Y= ½  120  2 =$120 46

  47. The producer surplus loss when a unit tax is imposed Loss in Producer Surplus = X + Y = $1,920 - $1,080 = $840 OR calculate the loss in producer surplus by adding the area of the rectangleX and the area of the triangle Y Area of rectangleX= 2  360 = $720 Area of triangle Y= ½  120  2 =$120 Therefore, loss in Producer Surplus= $840 47

  48. Determining the deadweight loss of a tax • Part of the consumer surplus loss and producer surplus loss goes to the government in the form of tax revenue (area V + X). • What about the area W+Y? No one gets this. This is a deadweight loss. 48

  49. Identifying the deadweight loss on a graph 49

  50. Identifying the deadweight loss on a graph Consumer surplus transferred to government 50

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