University:
Kentucky State University
Course:
ECO 301 | Microeconomics
Academic year:

2020
Views:

380

Pages:

4
Author:

do3ran7ut

Chapter 8 Application: The Costs of Taxation Welfare implications of a tax SupplyTax TAX Before tax CS = A + B + C PS = D + E + F Total surplus = (A + B + C + D + E + F) After Tax CS = A PS = F Total surplus = (A + F) Decrease in total surplus = - (B + C + D + E) Tax Revenue = B + D DWL = C + E Deadweight loss: the fall in total surplus that results from a market distortion  Taxes have deadweight losses because the quantity transacted is lower than the efficient quantity that maximized total surplus. (MB = MC)  The price elasticities of supply and demand will determine the size of the deadweight loss that occurs from a tax. (larger the elasticities imply larger DWL) 6 The Laffer Curve  Deadweight loss grows larger as a tax grows larger. Tax revenue first rises with the size of a tax, As the tax increases, the level of tax revenue will eventually fall.  As taxes increase, the deadweight loss rises more quickly than the size of the tax. [compare figure (a) and (b) tax doubles, DWL rises by more than double] Welfare implications of a Subsidy supplySubsidy H = Deadweight weight loss 7 Example: Chapter 8, Q3 Consider the market for rubber bands. (a) If this market has very elastic supply and very inelastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Use the tools of consumer surplus and producer surplus in your answer. (b) If this market has very inelastic supply and very elastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Contrast your answer with your answer to part (a) (a) With very elastic supply and very inelastic demand, the burden of the tax on rubber bands will be borne largely by buyers. Consumer surplus declines considerably, by area A + B, but producer surplus decreases only by area C+D. (b) With very inelastic supply and very elastic demand, the burden of the tax on rubber bands will be borne largely by sellers. Consumer surplus does not decline much, just by area A + B, while producer surplus falls substantially, by area C + D. Compared to part (a), producers bear much more of the burden of the tax, and consumers bear much less. Example: Chapter 8, Q9 Hotel rooms in Smalltown go for $100, and 1000 rooms are rented on a typical day. (a) To raise revenue, the mayor decides to charge hotels a tax of $10 per rented room. After the tax is imposed, the going rate for hotel rooms rises to $108, and the number of rooms rented falls to 900. Calculate the amount of revenue this tax raises for Smalltown and the dead weight loss of the tax. (b) The mayor now doubles the tax to $20. The price rises to $116, and the number of rooms rented falls to 800. Calculate tax revenue and deadweight loss with this larger tax. Are they double, more than double, or less than double? Explain. 8 (a) The tax revenue = A + B = ($10)(900) = $9,000. The deadweight = C + D = (0.5)($10)(100) = $500. (b) The tax revenue = A + B = ($20)(800) = $16,000. The deadweight = C + D, = (0.5)($20)(200) = $2,000. 9

Chapter 8 Application The Costs of Taxation

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