The incidence of a tax and its excess burden depend on the elasticites of demand and supply:
• For a given elasticity of supply, the buyer pays a larger share of the tax, the more inelastic is the demand for the good.
In Figure 7.2(a), the market is efficient with marginal benefit equal to marginal cost.
Total surplus—the sum of 2. Consumer surplus and 3. Producer surplus—is maximized.
2. A $10 tax on sellers of MP3 players shifts the supply curve to S + tax.
7.1 TAXES ON BUYERS AND SELLERS
3. The buyer’s price rises to $105—an increase of $5 a player.
4. The seller’s price falls to $95—a decrease of $5 a player.
5. The quantity decreases to 2,000 players a week.
6. The government’s tax revenue is $20,000.
Tax Incidence
Tax incidence is the division of the burden of a tax
between the buyer and the seller. When a good is taxed, it has two prices:
• A price that includes the tax • A price that excludes the tax Buyers respond to the price that includes the tax. Sellers respond to the price that excludes the tax.
2. A $10 tax on buyers shifts the demand curve to D – tax.
7.1 TAXES ON BUYERS AND SELLERS
3. The buyer’s price rises to $105—an increase of $5 a player.
7.1 TAXES ON BUYERS AND SELLERS
Tax Incidence, Inefficiency, and Elasticity of Supply
Perfectly Inelastic Supply: Seller Pays and Efficient Perfectly Elastic Supply: Buyer Pays and Inefficient Figures 7.4(a) and 7.4(b) illustrate these two extreme cases.
Marginal benefit equals marginal cost, so the outcome is efficient.
7.1 TAXES ON BUYERS AND SELLERS
Figure 7.3(b) shows tax incidence in a market with perfectly elastic demand— the market for pink pens.
Excess burden is the amount by which the burden of a tax exceeds the tax revenue received by the government.
7.1 TAXES ON BUYERS AND SELLERS
Incidence, Inefficiency, and Elasticity
The equilibrium quantity is less than the efficient quantity and a deadweight loss arises.
7.1 TAXES ON BUYERS AND SELLERS
Figure 7.2 shows the inefficiency of taxes.
The burden of the tax equals the tax revenue plus the deadweight loss.
7.1 TAXES ON BUYERS AND SELLERS
Excess burden is the
deadweight loss from a tax.
The excess burden is (3,000 $10 2), which equals $15,000.
7.1 TAXES ON BUYERS AND SELLERS
Figure 7.3(a) shows tax incidence in a market with perfectly inelastic demand— the market for insulin.
A tax of 20¢ a dose raises the price by 20¢, and the buyer pays all the tax.
7.1 TAXES ON BUYERS AND SELLERS
Tax Incidence, Inefficiency, and Elasticity of Demand
Perfectly Inelastic Demand: Buyer Pays and Efficient Perfectly Elastic Demand: Seller Pays and Inefficient Figures 7.3(a) and 7.3(b) illustrate these two extreme cases.
7.1 TAXES ON BUYERS AND SELLERS
Taxes and Efficiency
A tax places a wedge between the buyers’ price (marginal benefit) and the sellers’ price (marginal cost).
7.1 TAXES ON BUYERS AND SELLERS
Figure 7.1(b) shows what happens when the government taxes sellers of the MP3 players.
1. With no tax, the price is
$100 and 5,000 players a week are bought.
2 Explain how a price ceiling works and show how a rent ceiling creates a housing shortage, inefficiency, and unfairness.
3 Explain how a price floor works and show how the minimum wage creates unemployment, inefficiency, and unfairness.
7.1 TAXES ON BUYERS AND SELLERS
Figure 7.1(a) shows what happens when the government taxes buyers of the MP3 players.
1. With no tax, the price is $100 and 5,000 players are bought.
A tax of 10¢ a pink pen lowers the price received by the seller by 10¢, and the seller pays all the tax.
A deadweight loss arises, so the outcome is inefficient.
CHAPTER CHECKLIST
4 Explain how a price support in the market for an agricultural product creates a surplus, inefficiency, and unfairness.
7.1 TAXES ON BUYERS AND SELLERS
5. The government collects its tax revenue.
6. A deadweight loss arises.
7.1 TAXES ON BUYERS AND SELLERS
The loss of consumer surplus and producer surplus is the burden of the tax.
7.1 TAXES ON BUYERS AND SELLERS
Figure 7.2(b) shiency. A $10 tax shifts the supply curve to S + tax.
1. Marginal benefit exceeds 2. Marginal cost. 3. Consumer surplus and 4. Producer surplus shrink.
• For a given elasticity of demand, the seller pays a larger share of the tax, the more inelastic is the supply of the good.