Taxes Intro part 1 SFLS

Elasticity

Introduction to Taxes(part 1)

Introduction to Taxes:2.) Graphing Taxes3.) Efficacy and Fairness of Taxes1.) Some Tax Basics


Purposes of Taxes: Raise money to purchase the things that markets usually dont make. (public goods)

Restrict certain behaviors. (market failure)

Reallocate wealth. (subsidies)

1.) Some Tax Basics

4If you wish, you may delete this slide and give the information verbally as you cover the following slide.

What a Tax does in the Market:raises the price buyers pay lowers the price sellers receive. - reduces the quantity bought sold.

1.) Some Tax Basics


1.) Some Tax BasicsWhat a Tax does in the Market:raises the price buyers pay lowers the price sellers receive. - reduces the quantity bought sold. Purposes of Taxes: Raise money to purchase the things that markets usually dont make. (public goods)




Direct TaxesTaxes based on ownership.Paid directly to the government by people.

Example:Income taxes, property taxes.Indirect TaxesTaxes paid on a market transaction.Sellers usually pay to the government.

Example:sales taxes, VAT taxes.1.) Some Tax Basics - types



Example:sales taxes, VAT taxes.

1.) Some Tax Basics - typesOnly look at taxes in the market right now

2 important types of Indirect Taxes. 1.) Specific Tax

2.) Ad Valorem Tax

Indirect TaxesTaxes paid on a market transaction.Sellers usually pay to the government.

Example:sales taxes, VAT taxes.1.) Some Tax Basics - typesMore about these later

Tax effects on the market

1.) Some Tax basics- Tax increase prices, it doesnt change your idea of a product (Demand)

- but it does change how much you are willing to buy. (Quantity Demanded )So Supply line shifts, Not the Demand line!


Tax Incidence

The division of the burden of a tax between the buyer and the seller. Who pays more depends on elasticity.

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 with the tax.- Sellers respond to the price without the tax.

1.) Some Tax Vocabulary

Excess Burden

The deadweight loss from a taxthe amount by which the burden of a tax exceeds the tax revenue received by the government.

Tax Incidence1.) Some Tax Vocabulary


Two ways to understand taxes on a supply and demand graphTax effects on the marketI.) Graph 1 Shows what happens and its effect.

II.) Graph 2 Shows the effects and what happens.

2.) Graphing Taxes Its the same graph, just explain in two ways.


I. Graph 1 Tax SupplyA Tax is a suppliers input cost so a tax will shift the supply left the amount of the tax.

2.) Graphing Taxes


Changes (shifts) in SUPPLY (NOT quantity supplied)1.) Number of Sellers2.) Price of Resources or Inputs3.) Prices of Related Goodsi) Substitute in Productionii) Compliment in Production4.) Productivity 5.) Expectations

The short answer is: Everything else that is NOT due to a change in price!

5 main reasons:

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Changes (shifts) in SUPPLY 1.) Number of Sellers

2.) Number of Resources or Inputs

Example:Ceteris Paribus If you pay more Taxes = Less profit = Less supply

Taxes are just an input cost for suppliers.

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PAY MORE TAXES = An Input cost, so it is more expensive to produce the same thing so you produce less.Shifts of the Supply Curve

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PriceQuantityDecrease in supply

Figure Caption: Figure 3-9: Shifts of the Supply CurveAny event that increases supply shifts the supply curve to the right, reflecting a rise in the quantity supplied at any given price. Any event that decreases supply shifts the supply curve to the left, reflecting a fall in the quantity supplied at any given price.

Note to the instructor: When economists talk about an increase in supply, they mean a rightward shift of the supply curve: at any given price, producers supply a larger quantity of the good than before. And when economists talk about a decrease in supply, they mean a leftward shift of the supply curve: at any given price, producers supply a smaller quantity of the good than before.

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S + tax2.) Graphing Taxes - A Tax is a suppliers input cost so a tax will shift the supply left the amount of the tax.

Shift amount of the tax

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I. Graph 1 Tax Supply

2.) Graphing Taxes A.) A Tax is a suppliers input cost so a tax will shift the supply left the amount of the tax. B.) Tax increase prices, it doesnt change your idea of a product (Demand) but it does change how much you are willing to buy ( Quantity Demanded )C.) It doesnt matter if a tax is on the buyer or the seller. The same outcome will occur on market equilibrium.Shift Left

= Less Supply due to Higher Tax

Prices= Less Quantity Demanded

Prices

Market EQ


Wedge =

II. Graph 2 Tax is a Wedge 2.) Graphing Taxes


What a Tax does in the Market:raises the price buyers pay lowers the price sellers receive. - reduces the quantity bought sold.

1.) Some Tax BasicsThis second graph is the same as the first, it just doesnt show a shift, instead shows consumer and producer surplus, so it is easier to see why these parts here are true.


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S12.) Graphing Taxes - lowers the price sellers receive. - reduces the quantity bought sold. Tax amount= Wedge

Price buyers payAmount sellers get

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A.) A Tax puts a wedge between the demand and supply in a market by the amount of the tax.B.) The buyers price is the market Equilibrium price C.) Supplier get less revenue and some leave the market due to lower demand.

Prices= Less Quantity Demanded

= Some suppliers leave the market

= Market EQ

Price buyers pay follow up the demand curvePrice sellers get follow down the supply curveThe Tax the difference ( the size of the wedge)

Less Quantity Demanded

= Market EQ

II. Graph 2 Tax is a Wedge



Next, apply welfare economics to measure the gains and losses from a tax. We determine consumer surplus (CS), producer surplus (PS), tax revenue (T), total surplus (TS)

with the taxandwithout the tax.

3.) Efficacy and Fairness of Taxes

26If you wish, you may delete this slide and give the information verbally at the beginning of the next slide.

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Without a tax,

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QEQTABCDEFCS = A + B + CPS = D + E + FTax revenue = 0Total surplus= CS + PS= A + B + C + D + E + F


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QEQTABCDEFCS = APS = FTax revenue = B buyer pays+ D seller paysTotal surplus= A + B + D + F

With the tax,

The tax reduces total surplus by C + E3.) Efficacy and Fairness of Taxes

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QEQTABCDEFC + E is called the deadweight loss (DWL) or excess burden of the tax, the fall in total surplus that results from a market distortion , such as a tax. 3.) Efficacy and Fairness of Taxes

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PQA.Compute CS, PS, and total surplus without a tax.

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The market for airplane tickets3.) another example

In chapter 7, students learned how to compute the area of triangles representing CS, PS, and total surplus. This skill is required to do this exercise.

Most students will need a calculator to do part B.

Your students need not draw the graph in order to do these calculations. However, if your students are using the gutted student handouts we provide to accompany the Premium PowerPoint presentations, they will have parts of the graph on their handouts. Ask your students to shade the areas corresponding to CS, PS, tax revenue and DWL directly on the printed graphs.

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CS = x 200 x 100= 10,000Total surplus= 10,000 + 10,000= 20,000PS = x 200 x 100= 10,000

P =

3.) another exampleThe market for airplane tickets

PQB.If 100 tax per ticket, compute CS, PS, tax revenue, total surplus, and DWL.D

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The market for airplane tickets3.) another example

In chapter 7, students learned how to compute the area of triangles representing CS, PS, and total surplus. This skill is required to do this exercise.

Most students will need a calculator to do part B.

Your students need not draw the graph in order to do these calculations. However, if your students are using the gutted student handouts we provide to accompany the Premium PowerPoint presentations, they will have parts of the graph on their handouts. Ask your students to shade the areas corresponding to CS, PS, tax revenue and DWL directly on the printed graphs.

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CS = x 150 x 75= 5,625Total surplus = 18,750PS = 5,625Tax revenue= 100 x 75= 7,500DWL = 1,250

PS =

PB =

A 100 tax on airplane tickets3.) another example

To compute DWL, simply subtract total surplus with the tax ($18750) from total surplus without the tax ($20,000, which was computed on the preceding slide).

Equivalently, compute the area of the blue shaded triangle: x (100-75) x ($250 $150) = $1250.

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With the tax,

The tax reduces total surplus by C + E3.) Efficacy and Fairness of Taxes

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Size of tax = T

QT

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EQ with no tax: Price = PE Quantity = QE

PS

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EQEQ with tax = T per unit:Sellers receive PS Quantity = QT Buyers pay PB 3.) Efficacy and Fairness of Taxes

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Revenue from tax: T x QT PS

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EQQT

Size of tax = T

The Government Revenue3.) Efficacy and Fairness of Taxes

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Revenue from tax: Paid by the buyerPS

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EQQT

Size of tax = T

The Tax Incidence


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Revenue from tax: Paid by the sellerPS

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EQQT

Size of tax = T

3.) Efficacy and Fairness of TaxesThe Tax Incidence

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QEQTSince of the tax, the units between QT and QE are not sold. The value of these units to buyers is greater than the cost of producing them,so the tax prevents some mutually beneficial trades.

3.) Efficacy and Fairness of TaxesThe Excess Burden

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3.5) Elasticity of Taxes

CASE 1: Supply is more elastic than demand

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Tax

Buyers share of tax burden

Sellers share of tax burden

Price if no tax

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3.5) Elasticity of Taxes and Tax IncidenceIts easier for seller than buyers to leave the market.So buyers bear most of the burden of the tax.

4141We have just seen that tax incidence is not affected by whether the government makes buyers or sellers pay the tax. So what, then, does determine tax incidence? Turns out its elasticity specifically, the price elasticities of supply and demand.

There are two cases: 1) supply is more price-elastic than demand (this slide), and 2) demand is more price-elastic than supply (next slide).

When supply is more price-elastic than demand, sellers are relatively more responsive to changes in price, and the supply curve is less steep than the demand curve. Buyers have relatively fewer alternatives, so they have to eat most of the price increase caused by the imposition of the tax.

As the textbook puts it, sellers can more easily leave the market in response to the tax than can buyers. Thus, buyers are stuck bearing most of the burden of the tax.

CASE 2: Demand is more elastic than supply

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Price if no tax

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3.5) Elasticity of Taxes and Tax IncidenceIts easier for buyers than sellers to leave the market.So sellers bear most of the burden of the tax.

4242The size of the tax is the same in this diagram as in the one on the preceding slide.

When demand is more price-elastic than supply, buyers are relatively more price-sensitive, and the demand curve is less steep than the supply curve. Buyers have relatively more alternatives, so they can avoid most of the tax. Sellers are less flexible, so they have to eat a greater share of the price increase caused by the tax.

From the textbook: Buyers can more easily leave the market than sellers in response to the tax. Thus, sellers end up with most of the burden of the tax.

Introduction to Taxes:3.) Efficacy and Fairness of Taxes

3.5) Elasticity of Taxes- Taxes placed on the buyersIt doesnt matter is the tax is placed on the buyer or seller, both are players in the market, but just to show the elasticity issue, lets say the taxes are placed primarily on the buyer, the question is, who actually bears the burden of it?


3.5) Elasticity of Taxes- Taxes placed on the buyersIt doesnt matter is the tax is placed on the buyer or seller, both are players in the market, but just to show the elasticity issue, lets say the taxes are placed primarily on the buyer, the question is, who actually bears the burden of it?

Different elasticity means larger or smaller deadweight losses

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Size of tax

Buyer pays all and is Efficient MC = MB

No deadweight loss

DPS

PB

Taxes, DWL, and the Elasticity of DemandPerfectly Inelastic Demand

45The tax raises the price buyers pay and therefore reduces the quantity demanded. The equilibrium quantity falls below the surplus-maximizing quantity, but not by much when demand is price-inelastic.

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Size of taxDPS

PB

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Taxes, DWL, and the Elasticity of DemandInelastic Demand


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Size of taxDPS

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The more elastic is demandTaxes, DWL, and the Elasticity of DemandInelastic Demand


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Size of taxDPS

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The more elastic is demand the easier for buyers to leave the market when the tax increases PB,

Taxes, DWL, and the Elasticity of DemandInelastic Demand


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Size of taxDPS

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The more elastic is demandthe easier for buyers to leave the market when the tax increases PB, the more Q falls below the surplus-maximizing quantity, Taxes, DWL, and the Elasticity of DemandInelastic Demand


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Size of taxDPS

PB

The more elastic is demandthe easier for buyers to leave the market when the tax increases PB, the more Q falls below the surplus-maximizing quantity, and the greater the DWL. Taxes, DWL, and the Elasticity of DemandElastic Demand


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Size of taxD

The more elastic is demandthe easier for buyers to leave the market when the tax increases PB, the more Q falls below the surplus-maximizing quantity, and the greater the DWL. PS

PB

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Taxes, DWL, and the Elasticity of DemandElastic Demand


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Size of taxDPS

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Buyer pays none of the tax and is not efficient

Large Deadweight LossLarge Excess Burden

Taxes, DWL, and the Elasticity of DemandPerfectly Elastic Demand


For a given Supply curve, if Demand is:

1.) Perfectly Inelastic Demand: Buyer Pays and Efficient

2.) Inelastic Demand: Buyer pays a higher portion

3.) Perfectly Elastic Demand: Seller Pays and Inefficient

4.) Elastic Demand: Buyer pays a smaller portion

3.5) Elasticity of Taxes- Taxes placed on the buyers

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3.5) Elasticity of Taxes- Taxes placed on the sellersIt doesnt matter is the tax is placed on the buyer or seller, both are players in the market, but just to show the elasticity issue, lets say the taxes are placed primarily on the buyer, the question is, who actually bears the burden of it?

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A tax does not change the price paid by the buyer but lowers the price received by the sellerMC = MB Seller pays the entire tax and is efficientNo deadweight loss

Taxes, DWL, and the Elasticity of DemandPerfectly Inelastic Supply

55When theres no tax, the market equilibrium quantity maximizes total surplus.

The tax causes the price sellers receive to fall, so sellers will supply a smaller quantity, and the new equilibrium quantity falls below the one that maximizes total surplus hence the DWL.

When supply is inelastic, sellers do not reduce Q much below the surplus-maximizing quantity, so DWL is small.

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Taxes, DWL, and the Elasticity of DemandInelastic Supply




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Size of tax

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The more elastic Supply isTaxes, DWL, and the Elasticity of DemandInelastic Supply




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Size of tax

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The more elastic Supply isits easier for firms to leave the market when the tax reduces PS.Taxes, DWL, and the Elasticity of DemandInelastic Supply




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The more elastic Supply isits easier for firms to leave the market when the tax reduces PS.Tax begins to reduce Q even moreTaxes, DWL, and the Elasticity of DemandInelastic Supply




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The more elastic Supply isits easier for firms to leave the market when the tax reduces PS.Tax begins to reduce Q even moreand DWL becomes largerTaxes, DWL, and the Elasticity of DemandElastic Supply




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Size of tax

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Size of tax

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Buyer pays all of the tax and is not efficient

Large Deadweight LossLarge Excess Burden

Taxes, DWL, and the Elasticity of DemandPerfectly Elastic Supply




For a given Demand curve, if Supply is:

1.) Perfectly Inelastic Supply: Seller Pays and Efficient

2.) Inelastic Supply: Seller pays a higher portion

3.) Perfectly Elastic Supply: Buyer Pays and Inefficient

4.) Elastic Supply: Seller pays a smaller portion

3.5) Elasticity of Taxes- Taxes placed on the sellers

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What should the Government tax?1.) Which goods or services should government tax to raise the revenue it needs?

So

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Ways to interpret Economic theory Positive economics is the study of what is

Normative economics is the study of what should be

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What should the Government tax?1.) Which goods or services should government tax to raise the revenue it needs? SoOne answer: Those things with the smallest DWL

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2.) When is the DWL small vs. large?

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2.) When is the DWL small vs. large?

Turns out it depends on the price elasticity of supply and demand.

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So a recap3.) Efficacy and Fairness of Taxes3.5) Elasticity of Taxes

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Price if no tax

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CASE 2: Demand is more elastic than supply

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Price if no tax

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3.5) Elasticity of Taxes and Tax IncidenceIts easier for buyers than sellers to leave the market.So sellers bear most of the burden of the tax.

7272The size of the tax is the same in this diagram as in the one on the preceding slide.

When demand is more price-elastic than supply, buyers are relatively more price-sensitive, and the demand curve is less steep than the supply curve. Buyers have relatively more alternatives, so they can avoid most of the tax. Sellers are less flexible, so they have to eat a greater share of the price increase caused by the tax.

From the textbook: Buyers can more easily leave the market than sellers in response to the tax. Thus, sellers end up with most of the burden of the tax.


2.5.) Types of Taxes



Example:sales taxes, VAT taxes.

1.) Some Tax Basics - types


2.) Ad Valorem Tax



Different types of taxes can have different types of outcomesSpecific Tax

Tax on the final good or service in the market and is a fixed amount.

- Will cause a parallel shift in the supply curve. (Unit Tax)

(Excise Tax)

Two types of indirect Taxes.

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S1Tax on the final good or service in the market.

- Will cause a parallel shift in the supply curve. Specific Tax


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Two types of indirect Taxes. Only apply tax at the end of the production process when good is in the market

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Different types of taxes can have different types of outcomesSpecific TaxTwo types of indirect Taxes. Ad Valorem Tax

(Percentage Tax)

(VAT Tax)

Tax on any value added in the production process.

- Will cause a Pivot in the supply curve.

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S1Tax on any value added in the production process.

- Will cause a Pivot in the supply curve. Two types of indirect Taxes. Ad Valorem Tax

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This is because you tax the entire production process. Each step adds value Tax the value added

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So to Summarize so far

1.) Some Tax BasicsWhat a Tax does in the Market:raises the price buyers pay lowers the price sellers receive. - reduces the quantity bought sold. Purposes of Taxes: Raise money to purchase the things that markets usually dont make. (public goods)




Tax effects on the market

1.) Some Tax basics- Tax increase prices, it doesnt change your idea of a product (Demand)

- but it does change how much you are willing to buy. (Quantity Demanded )


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S12.) Graphing Taxes - lowers the price sellers receive. - reduces the quantity bought sold. Tax amount= Wedge

Price buyers payAmount sellers get

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With the tax,

The tax reduces total surplus by C + EThe Welfare Effects of a Tax

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Price if no tax

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2.) Ad Valorem Tax



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More of this will be mentioned in the second powerpoint on Taxes

The End of part 1Thank you

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Taxes Intro part 1 SFLS

Education

Transcript of Taxes Intro part 1 SFLS