Chapter 8 - Application: The Costs of Taxation

Question 1

Deadweight Loss and Market Distortion

Answer 1

Total welfare changes in the market, including a negative change in consumer surplus, a negative change in producer surplus, and a positive change in tax revenue.

Deadweight loss represents the overall decrease in market happiness (total surplus) caused by the tax.

Taxes distort market incentives, leading to a smaller market size and inefficient resource allocation

Question 1

Tax Revenue

Answer 1

The amount that the government receives from taxes (T x Q)

Rectangular area under the demand curve but above the supply curve

The height is the size of the tax, and the width is quantity sold

Question 2

Total Surplus and Deadweight Loss

Answer 2

Deadweight loss is the result of taxation, when it prevents sellers and buyers from obtaining their full gains from trade

It represents a reduction in the total surplus of a market, making both buyers and sellers worse off.

The deadweight loss in this scenario is the value of the transaction that doesn’t happen because of the tax.

Question 3

Deadweight Loss and Elasticity

Answer 3

With a more inelastic supply or demand curve, the less deadweight loss. This is because the tax revenue is greater with inelastic demand. (think of the graph, the more vertical the curves are, the bigger the tax revenue area)

Question 4

Laffer Curve

Answer 4

Finding a balance in taxation and government revenue

If a tax is too small it wont gain sufficient tax revenue

If a tax is medium, it finds a good level of government tax, but it has a bigger deadweight loss

If a tax is too big it overpowers the government revenue, the area of the deadweight loss becomes greater than the revenue area