APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION
-
Upload
vladimir-valenzuela -
Category
Documents
-
view
25 -
download
1
description
Transcript of APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION
![Page 1: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/1.jpg)
APPLICATIONS OF WELFARE ECONOMICS:THE COST OF TAXATION
![Page 2: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/2.jpg)
Overview
• How do taxes affect the economic well-being of market participants?
– We can use the tools of welfare economics (consumer and producer surplus) to answer that question.
• In chapter 6 we learned that it does not matter whether a tax on a good is levied on buyers or sellers of the good . . . the price paid by buyers rises, and the price received by sellers falls.
• In this chapter we examine the “Distortions” and welfare losses in markets subject to taxation
![Page 3: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/3.jpg)
How a Tax Affects Market Participants
• A tax places a wedge between the price buyers pay and the price sellers receive.
• Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax.
• The size of the market for that good shrinks.
• As a result, there is a loss in consumer and producer surplus.
• That loss is known as the deadweight loss of taxation
![Page 4: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/4.jpg)
Deadweight Loss of Taxation
Quantity
Price
D1
S1
PD
PS
P1
Q1
A per-unit tax drives a wedge between the price
paid by consumers and the price received by
suppliers. As a result, output falls as does
consumer and producer surplus
Tax Wedge
QTax
Loss in Consumer Surplus
Loss in Producer Surplus
![Page 5: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/5.jpg)
Deadweight Loss of Taxation
Quantity
Price
D1
S1
PD
PS
P1
Q1QTax
The area to the left of the tax wedge represents
government tax revenue, the area to the right of the tax wedge represents the
deadweight loss of taxation
Tax RevenueDeadweight loss of
taxation
![Page 6: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/6.jpg)
Deadweight Loss of Taxation
Quantity
Price
D1
S1
PD
PS
P1
Q1QTax
A
BC
D E
F
Consumer Surplus without tax: A+B+C
Producer Surplus without tax: D+E+F
Consumer Surplus with tax: A
Producer Surplus with Tax: F
Government tax Revenue: B+D
Deadweight loss of taxation: C+E
![Page 7: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/7.jpg)
How a Tax Affects Welfare
![Page 8: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/8.jpg)
How a Tax Affects Market Participants
• The change in total welfare includes:
– The change in consumer surplus,
– The change in producer surplus, and
– The change in tax revenue.
– The losses to buyers and sellers exceed the revenue raised by the government.
– This fall in total surplus is called the deadweight loss.
![Page 9: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/9.jpg)
The Magnitude of Deadweight Loss
• What determines whether the deadweight loss from a tax is large or small?
– The magnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price.
– That, in turn, depends on the price elasticitiesprice elasticities of supply and demand.
![Page 10: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/10.jpg)
The Magnitude of Deadweight Loss
• The greater the elasticities of demand and supply:
– the larger will be the decline in equilibrium quantity and,
– the greater the deadweight loss of a tax.
• The smaller the elasticities of demand and supply:
– the smaller will be the decline in equilibrium quantity and,
– the smaller the deadweight loss of a tax.
![Page 11: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/11.jpg)
Deadweight Loss: Inelastic Supply & Demand
P
Q
D
S
P1
Q1Qt
Deadweight Loss (DWL)tax
When demand and/or supply is
inelastic, the deadweight loss
of taxation is small
![Page 12: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/12.jpg)
Deadweight Loss: Elastic Supply & Demand
P
Q
D
S
P1
Q1Qt
Deadweight Loss (DWL)
tax
When demand and/or supply is
elastic, the deadweight loss
of taxation is large
![Page 13: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/13.jpg)
Deadweight Loss and the Size of a Tax
• With each increase in the tax rate, the deadweight loss of the tax rises even more rapidly than the size of the tax.
– Doubling the tax rate will more than double the deadweight loss of taxation
![Page 14: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/14.jpg)
Deadweight Loss with a Small Sized Tax
P
0 Q
D
S
P1
Q1
Per Unit Tax
Qt
PD
PS
Deadweight Loss (DWL)
Tax Revenue
![Page 15: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/15.jpg)
Deadweight Loss with a Medium Sized Tax
P
0 Q
D
S
P1
Q1
Per Unit Tax
Qt
PD
PS
Deadweight Loss (DWL)
Tax Revenue
![Page 16: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/16.jpg)
Deadweight Loss with a Large Sized Tax
P
0 Q
D
S
P1
Q1
Per Unit Tax
Qt
PD
PS
Deadweight Loss (DWL)
Tax Revenue
![Page 17: APPLICATIONS OF WELFARE ECONOMICS: THE COST OF TAXATION](https://reader036.fdocuments.us/reader036/viewer/2022062408/568134da550346895d9c0b1e/html5/thumbnails/17.jpg)
The Relationship Between Deadweight Loss and the Size of a Tax
DeadweightLoss
0 Tax Size