Supply, Demand and Government Policies

Chapter 6

Copyright © 2001 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of any part of thework should be mailed to:

Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Taxes

Governments levy taxes to raise revenue for public

projects.

What are some potential impacts of taxes?

Taxes discourage market activity.

When a good is taxed, the quantity sold is smaller.

Buyers and sellers share the tax burden.

Taxes

Tax incidence is the study of who bears the burden of a tax.

Taxes result in a change in market equilibrium.

Buyers pay more and sellers receive less, regardless of whom the tax is levied on.

Impact of a 50¢ Tax Levied on Buyers...

3.00

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

100

D1

Supply, S1

A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).

D2

Copyright © 2001 by Harcourt, Inc. All rights reserved

3.00

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

10090

$3.30

Pricebuyerspay

D1

D2

Equilibriumwith tax

Supply, S1

Equilibrium without tax

Impact of a 50¢ Tax Levied on Buyers...

2.80

Pricesellersreceive

Copyright © 2001 by Harcourt, Inc. All rights reserved

Pricewithouttax

Tax ($0.50)

What was the impact of tax?

Taxes discourage market activity.

When a good is taxed, the quantity sold is smaller.

Buyers and sellers share the tax burden.

3.00

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

10090

S1

S2

Demand, D1

Impact of a 50¢ Tax on Sellers...

Price without tax

2.80

Price sellers receive

$3.30

Price buyers pay

Equilibrium without tax

Copyright © 2001 by Harcourt, Inc. All rights reserved

A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50).

Tax ($0.50)

Equilibriumwith tax

Impact of TaxesTax Wedges

Taxes on buyers and taxes on sellers are equivalent.

Taxes place a wedge between what the sellers receive and what the buyer pays.

The wedge shifts the relative position of the supply and demand curve so that buyers and sellers share the burden of the tax.

The Incidence of Tax

In what proportions is the burden of the tax divided?

How do the effects of taxes on sellers compare to those levied on buyers?

The answers to these questions depend on the elasticity of demand and the elasticity of supply.

Elastic Supply, Inelastic Demand...

Quantity0

Price

Demand

Supply

Tax

1. When supply is moreelastic than demand...

2. ...theincidence of thetax falls moreheavily onconsumers...

3. ...than onproducers.

Price without tax

Price buyers pay

Price sellers receive

Inelastic Supply, Elastic Demand...

Quantity0

Price

Demand

Supply

Price without tax

Tax

1. When demand is moreelastic than supply...

2. ...theincidence of the tax falls more heavily on producers...

3. ...than on consumers.

Price buyers pay

Price sellers receive

So, how is the burden of the tax divided?

The burden of a tax falls more heavily on the side of the market that is less

elastic.