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Lecture 15

ECON 101 Lecture Notes - Lecture 15: Lead, Economic Surplus, Marginal Utility
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Winter 2015
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Department
Economics
Course Code
ECON 101
Professor
Marina Adshade
Lecture
15

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ECON 101 - Lecture #15 - Welfare Effects of Quantity Taxes
Introduction
In this lecture, we will examine how quantity taxes affect
Welfare of consumers and producers
Total gains from trade
Total gains of trade before tax = CS (consumers surplus) + PS (producer surplus)
Total gains of trade after tax = CS + PS +GR (government revenue)
To calculate total gains after trade, government revenue needs to be considered
Government Revenue
GR = quantity sold after tax multiplied by tax
Represented by Figure 1
Figure 1. The graph representing how government revenue is presented in a graphical sense.
Now we know that after tax is implemented, government revenue increases
Is that the only thing that changed?
How a Tax impacts Total Gains
Examine Figure 2, and analyze Table 1
Figure 2. The graph dividing the demand and supply function into sections.
Table 1. The table comparing consumer surplus, producer surplus, tax revenues, and total
surplus before and after tax.
Without Tax With Tax Change
Consumer Surplus A+B+C A -B-C
Producer Surplus D+E+F F -D-E
Tax Revenue 0 B+D +B+D
Total Surplus A+B+C+D+E+F A+B+D+F -C-E
From Table 1, one can see that after tax is implemented total gains decreased by C and
E
This regions is referred to as the deadweight loss
Deadweight Loss
Deadweight loss appears whenever the free market is intervened (with tax, tariffs,
monopoly, etc.)
It is a sign that the market is not at its most efficient state
It represents the gains from trade that would be occurred if tax was not implemented
Examining figure 1, after the price buyer pays increased from P* to Pb, some
buyers quit the market because it exceeds their marginal willingness to pay (their
gains from trade is represented by area C)
After the price sellers receive decreased from P* to Ps, some producers quite the
market because it is lower than their marginal cost (their gains from trade is
represented by area E)
Obvious, we want to minimize deadweight loss as much as possible
How do we achieve that?

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Description
ECON 101 - Lecture #15 - Welfare Effects of Quantity Taxes Introduction ● In this lecture, we will examine how quantity taxes affect ○ Welfare of consumers and producers ○ Total gains from trade ● Total gains of trade before tax = CS (consumers surplus) + PS (producer surplus) ● Total gains of trade after tax = CS + PS +GR (government revenue) ● To calculate total gains after trade, government revenue needs to be considered Government Revenue ● GR = quantity sold after tax multiplied by tax ● Represented by Figure 1 Figure 1. The graph representing how government revenue is presented in a graphical sense. ● Now we know that after tax is implemented, government revenue increases ○ Is that the only thing that changed? How a Tax impacts Total Gains ● Examine Figure 2, and analyze Table 1 Figure 2. The graph dividing the demand and supply function into sections. Table 1. The table comparing consumer surplus, producer surplus, tax revenues, and total surplus before and after tax. Without Tax With Tax Change Consumer Surplus A+B+C A -B-C Producer Surplus D+E+F F -D-E Tax Revenue 0 B+D +B+D Total Surplus A+B+C+D+E+F A+B+D+F -C-E ● From Table 1, one can see that after tax is implemented total gains decreased by C and E ● This regions is referred to as the deadweight loss Deadweight Loss ● Deadweight loss appears whenever the free market is intervened (with tax, tariffs, monopoly, etc.) ● It is a sign that the market is not at its most efficient state ● It represents the gains from trade that would be occurred if tax was not implemented ○ Examining figure 1, after the price buyer pays increased from P* to Pb, some buyers quit the market because it exceeds their marginal willingness to pay (their gains from trade is represented by area C) ○ After the price sellers receive decreased from P* to Ps, some producers quite the market because it is lower than their marginal cost (their gains from trade is represented by area E) ● Obvious, we want to minimize deadweight loss as much as possible ○ How do we achieve that? ○ The answer lies in elasticity (as presented in Figure 3) Figure 3. Four graphs presented how deadweight losses change with different elasticities of demand and supply. ● Thereby, ALl other conditions being equal, tax should be levied on goods and services that are supplied and/or demanded inelastically to minimize deadweight loss ○ However, minimizing deadweight loss obvious is not the only concern ○ Ex. the demand for insulin is very inelastic, but that does not mean we should levy more tax on insulin Question 1 ● Government needs to raise some revenue. There are currently three option to consider, including taxing coffee beans, people, or properties. Order the three options from largest to smallest deadweight loss that will occur if a tax is levied. ○ Compare the elasticities of three things ○ Coffee beans is more elastic than properties which is more elastic than people ○ Thereby, the property order should be people, properties, and coffee beans ● Taxing people was actually a policy introduced by UK under Margaret Thatcher’s government ○ She knows a little about economics, and she understand the be
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