Chapter 6 (3)

Question 1

Taxes

Answer 1

the main way that gov’t raise revenue to pay for pubic program

► Can also be used to correct market failures & encourage / discourage production & consumption of particular goods

► Similar to price floors & price ceilings –> they can have unintended consequences

Question 2

Example of Taxes

Answer 2

fatty foods & over-eating.

► when a good = taxed –> either the buyer / seller = must pay some extra amount to the gov’t on top of the sale price

Question 3

TAXES HAVE (2) PRIMARY EFFECTS:

Answer 3

1. Discourage production and consumption of the good that is taxed.
   2. Raise government revenue through the fees paid by those who continue buying and selling the good.
      ; therefore provides a new source of public revenue

Question 4

A TAX ON SELLERS (how will buyers & sellers respond?)

Answer 4

1. Does a tax on sellers affect supply? Yes, supply decreases.
   
   2. Does a tax on sellers affect demand? No, demand stays the same.
   3. How does a tax on sellers = affect the market equilibrium? The equilibrium price rises and quantity demanded falls.

Question 5

Does a tax on sellers affect supply?

Answer 5

Yes, supply decreases.

► At any market price –> sellers will behave as if the price they are receiving = actually $0.20 lower.

Question 6

Does a tax on sellers affect demand?

Answer 6

No, demand stays the same.

► Demand stays the same b/c the tax = does not change any of the non-price determinants of demand

►At any given price –> buyers’ desire to purchase = unchanged
○ However, the quantity demanded = may change–does change; although the curve itself doesn’t change

Question 7

How does a tax on sellers = affect the market equilibrium?

Answer 7

The equilibrium price rises and quantity demanded falls.

►The new supply curve = causes the equilibrium point to move up along the demand curve
○ b/c buyers now face a higher price –> they demand fewer quantity

► Notice @ the new equilibrium point –> the quantity demanded = lower & the price is higher
○ Taxes = usually reduce the quantity of a good / service that is sold –> shrinking the market

Question 8

Considering the market price now = $0.60, and the sellers = have to pay the gov’t $0.20 –> what sellers actually receive is $0.40

Answer 8

Ultimately, sellers do not receive the full price that consumers pay –> b/c the tax creates what is known as a tax wedge between buyers & sellers

►for each item sold @ the new equilibrium point –> the gov’t = collects tax revenue (which will need to be calculated)

Question 9

just like price control, a tax causes dead weight loss & redistributes surplus

Answer 9

► We can see the dead weight loss caused by the reduced # of trades

► It is surplus lost to buyers & sellers who would have been willing to make trades at the pre-tax equilibrium price

Question 10

the distribution of surplus –> however = trickier to follow

Answer 10

Under a tax, BOTH producers & consumers lose surplus (read pg. 181)

► The difference between this lost surplus & dead weight loss –> is that it doesn’t disappear

► Instead it becomes government revenue

in fact, the area representing gov’t revenue = exactly the same as the surplus lost to buyers & sellers still trading in the market after the has been imposed

► this revenue = can pay for services that might transfer surplus back to producers / consumers (or both, or to people outside of the market)

Question 11

A TAX ON BUYERS

Answer 11

what happens if the tax = imposed on buyers instead of sellers?
► The outcome is the same

Example, enacts a sale tax of $0.20
► In this case the demand curve –> rather than the supply curve = moves by the amount of tax

○ But the resulting equilibrium price & quantity = the same

Question 12

WHO BEARS THE BURDEN OF A TAX

Answer 12

We’ve seen that the outcome of a tax = does not depend on who pays it

► Whether a tax = levied on buyers / on sellers –> the cost is shared (aka the effects are identical)

Question 13

But which group bears more of the burden?

Answer 13

often, however, the tax burden = not split equally.

► Sometimes one group = carries much more of it than the other.

Question 14

TAX INCIDENCE

Answer 14

the relative tax burden borne by buyers & sellers

Question 15

what determines the incidence of a tax?

Answer 15

The relative elasticity of the supply & demand curves

► Since a tax effectively changes the price of a good to both buyers & sellers –> the relative responsiveness of supply & demand = will determine the tax burden

► Essentially, the side of the market that is more price elastic will be more able to adjust to price changes and will shoulder less of the tax burden

Question 16

recall that the market outcome of a tax–the new equilibrium quantity and price–is the same regardless of whether a tax = imposed on buyers / on sellers

Answer 16

Thus, the tax burden will be the same no matter which side of the market is taxed

► The actual economic incidence of a tax = unrelated to the statutory incidence–that is, the person who is legally responsible for paying the tax

**note, policy makers = little control over how the tax burden = shared between buyers & sellers