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Deadweight Loss And Tax Revenue As Taxes Vary

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Deadweight Loss And Tax Revenue As Taxes Vary

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Deadweight Losses And The Gains From Trade

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Deadweight Losses And The Gains From Trade

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Tax revenue measures the public benefit from the tax

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Welfare with a Tax—TS is CS + PS + tax revenue – deadweight loss

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Welfare without a Tax—TS is area between supply and demand up to equilibrium

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The impact of a tax on a market outcome is the same whether the tax is levied on buyers

or sellers of a good

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A tax on a good causes the size of the market for the good to shrink

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The loss to buyers and sellers from a tax exceeds the revenue raised by the gov.

Because taxes distort incentives, markets allocate resources inefficiently

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Deadweight loss—the fall in total surplus that results from a market distortion (ex. tax)

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Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade

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The greater the Elasticities of supply and demand, the greater the deadweight loss of a tax

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The greater the Elasticities of supply and demand, the greater the deadweight loss of a tax

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The more elastic, the more deadweight loss

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Reason—people respond more to the change in price

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Labor tax (Social Security) is about 40%

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The deadweight loss is in question because disagreement on elasticity of labor supply

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As taxes rise, the deadweight loss also rises (if double, the deadweight is 22 and if triple then 32)

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As taxes rise, the deadweight loss also rises (if double, the deadweight is 22 and if triple then 32)

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The more elastic supply and demand in any market, the more taxes distort behavior and the more likely a tax cut will increase tax revenue

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The more elastic supply and demand in any market, the more taxes distort behavior and the more likely a tax cut will increase tax revenue

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The revenue government gains or losses from tax change is computed by looking at tax rates andhow the tax change affects people’s behavior

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The revenue government gains or losses from tax change is computed by looking at tax rates andhow the tax change affects people’s behavior

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When the tax is too large, reducing the tax would actually increase tax revenue

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Cuts in tax rates encourages people to increase the quantity of labor they supplied

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Chap 7 : Consumers, Producers, and the Efficiency of Markets

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Chap 7 : Consumers, Producers, and the Efficiency of Markets

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Welfare economics studies how the allocation of resources affects economic well-being.

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Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays:
CS  =  WTP  –  P

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A buyer’s willingness to pay for a good is the maximum amount the buyer will pay for that good
WTP measures how much the buyer values the good

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At any Q, the height of the D curve is the WTP of the marginal buyer, the buyer who would leave the market if P were any higher.

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Total CS equals the area under the demand curve above the price, from 0 to Q.

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How a Lower Price Raises Consumer Surplus

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How a Lower Price Raises Consumer Surplus

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• Buyers pay less, so more CS
• New buyers enter market

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Producer surplus : the amount a seller is paid for a good minus the seller’s cost
PS = P – cost

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Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost).  Includes cost of all resources used to produce good, including value of the seller’s time.

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A seller will produce and sell the good/service only if the price exceeds his or her cost. Hence, cost is a measure of willingness to sell

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At each Q, the height of the S curve is the cost of the marginal seller, the seller who would leave the market if the price were any lower.

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Total PS equals the area above the supply curve under the price, from 0 to Q.

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How a Higher Price Raises Producer Surplus

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How a Higher Price Raises Producer Surplus

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As the price rises, the sellers produce more surplus and new sellers enter the market

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CS  = (value to buyers) – (amount paid by buyers)
=buyers’ gains from participating in the market
PS  = (amount received by sellers) – (cost to sellers)
= sellers’ gains from participating in the market
Total surplus = CS + PS
= total gains from trade in a market
= (value to buyers) – (cost to sellers)

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Efficiency-the property of a resource allocation of maximizing the total surplus received by all members of society
Equality- the property of distributing economic prosperity uniformly among the members of society (whether buyers and sellers have similar level of economic wellbeing)

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On the graph, consumer surplus is the area between P and the D curve.
On the graph, producer surplus is the area between P and the S curve.

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the buyers who value the good most highly are the ones who consume it.

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the sellers with the lowest cost produce the good.

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The market eq’m quantity maximizes total surplus:At any other quantity, can increase total surplus by moving toward the market eq’m quantity.

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is a numerical measure of the responsiveness of  Qd  or  Qs  to one of its determinants.

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Measures how much Qd responds to a change in P.

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Calculating Percentage Changes ( Standard method )

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Calculating Percentage Changes ( Standard method )

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Calculating Percentage Changes ( midpoint method )

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Calculating Percentage Changes ( midpoint method )

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The extent to which close substitutes are available

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The extent to which close substitutes are available

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Price elasticity is higher when close substitutes are available.

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How broadly or narrowly the good is defined

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How broadly or narrowly the good is defined

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Price elasticity is higher for narrowly defined goods than broadly defined ones.

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The time horizon – elasticity is higher in the long run than the short run 

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The time horizon – elasticity is higher in the long run than the short run 

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:  Price elasticity is higher in the
long run than the short run.

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Whether the good is a necessity or a luxury

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Whether the good is a necessity or a luxury

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Price elasticity is higher for luxuries than for necessities.

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The price elasticity of demand is closely related to the slope of the demand curve.

Rule of thumb:
The flatter the curve, the bigger the elasticity.
The steeper the curve, the smaller the elasticity

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“Perfectly inelastic demand”  (one extreme case)

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“Perfectly inelastic demand”  (one extreme case)

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“Perfectly elastic demand”  (the other extreme)

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“Perfectly elastic demand”  (the other extreme)

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The slope of a linear demand curve is constant but its elasticity s not.

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If demand is elastic, then price elast. of demand  > 1% change in Q  >  % change in P

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The fall in revenue from lower Q is greater
than the increase in revenue from higher P,
so revenue falls.

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measures how much Qs responds to a change in P.

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For many goods, price elasticity of supply is greater in the long run than in the short run, because firms can build new factories or new firms may be able to enter the market.

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The more easily sellers can change the quantity they produce, the greater the price elasticity of supply.

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-The slope of the supply curve is closely related to price elasticity of supply.

-Rule of thumb:
The flatter the curve, the bigger the elasticity.
The steeper the curve, the smaller the elasticity.

-Five different classifications.…

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“Perfectly elastic”  (the other extreme)

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“Perfectly elastic”  (the other extreme)

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:  measures the response of Q d to a change in consumer income

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measures the response of demand for one good to changes in the price of another good

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CHAP 6: Supply, Demand, and Government Policies

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CHAP 6: Supply, Demand, and Government Policies

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Government Policies That Alter the Private Market Outcome

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Government Policies That Alter the Private Market Outcome

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Price controls

Taxes

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Price ceiling:  a legal maximum on the price
of a good or service   Example: rent control

Price floor:  a legal minimum on the price of
a good or service   Example: minimum wage

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The goverment can make buyers or sellers pay a specific amount on each unit bought/sold.

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Chap 4: The Market Forces of Supply and Demand

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Chap 4: The Market Forces of Supply and Demand

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How Price Ceilings Affect Market Outcomes

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How Price Ceilings Affect Market Outcomes

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not binding

binding constraint

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A price ceiling above the eq’m price is not binding – has no effect on the market outcome.  

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A price ceiling above the eq’m price is not binding – has no effect on the market outcome.  

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The eq’m price ($800) is above the ceiling and therefore illegal.

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The eq’m price ($800) is above the ceiling and therefore illegal.

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The ceiling is a binding constraint on the price, causes a shortage.

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In the long run, supply and demand are more price-elastic. 

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In the long run, supply and demand are more price-elastic. 

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So, the shortage is larger.

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when prices are not controlled,
the rationing mechanism is efficient (the goods
go to the buyers that value them most highly)
and impersonal (and thus fair).

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not binding

binding constraint

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A price floor below the eq’m price is not binding – has no effect on the market outcome.  

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A price floor below the eq’m price is not binding – has no effect on the market outcome.  

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The eq’m wage ($4) is below the floor and therefore illegal.

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The eq’m wage ($4) is below the floor and therefore illegal.

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The floor is a binding constraint on the wage, causes a surplus (i.e., unemployment).

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Min wage laws
do not affect
highly skilled workers.

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Policymakers often restrict prices to help the poor, but these controls can actually harm society more than they help.

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The government imposes taxes on goods and services to fund national defense and public schools, either by a percentage of the price or a specific unit sold.

A Tax on Buyers

A Tax on Sellers

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a tax on buyers shifts the D curve down by the amount of the tax

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A tax on sellers shifts the S curve up by the amount of the tax