Chapter 8 Application: The Costs of Taxation

Question 1

What is the deadweight loss of taxation?

Answer 1

Deadweight loss is the reduction in total surplus that occurs because taxes distort incentives and reduce the size of the market​​.

Question 2

How does a tax affect buyers, sellers, and the government?

Answer 2

Taxes increase the price buyers pay, decrease the price sellers receive, and generate revenue for the government, but they also reduce the quantity sold​​.

Question 3

Why does the size of a tax affect deadweight loss?

Answer 3

The deadweight loss of a tax grows disproportionately as the size of the tax increases because it depends on the square of the tax size​​.

Question 4

What is the Laffer Curve?

Answer 4

The Laffer Curve illustrates the relationship between tax rates and tax revenue, showing that revenue can decrease if taxes are too high, as they shrink the market​​.

Question 5

What determines the size of deadweight loss from a tax?

Answer 5

The elasticity of supply and demand. More elastic markets have larger deadweight losses because quantity responds more significantly to price changes caused by the tax​​.

Question 6

Why do taxes lead to efficiency losses?

Answer 6

Taxes discourage mutually beneficial trades between buyers and sellers, reducing the total surplus below its maximum level​​.