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L9 - Supply, Demand and Government Policy -10072013.pdf

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University of Toronto St. George
James Pesando

Tax levied on seller: seller sends tax to government Tax levied on buyer: buyer sends tax Observations: Sales tax is usually levied on seller Incidence of tax does not depend upon whether tax is levied on buyer or seller Refer to Case #2: Sales Tax Levied on Buyers from Lecture 8 DD Shifts Vertically Downward by $10 if $10 Tax is Levied on Buyers $10 Tax Levied on Buyers Price paid by buyer: 95 + 10 = 105 Price received by seller: 95 BOTH CASES: TAX INCIDENCE IS THE SAME Buyer pays $105 (not $100) Seller receives $95 (not $100) NOTE: When tax levied on seller, buyer pays market price (and seller receives market price LESS tax) When tax levied on buyer, buyer pays market price PLUS tax (and seller receives market price) Demand Elasticities and the Incidence of a Tax $10 Tax to be Paid by Seller Perfectly Inelastic Demand Buyer pays: P1 = P0 + 10 (Full incidence) Seller receives: P1 - 10 = (P0 +10) - 10 = P0 (no change) Perfectly Elastic Demand Buyer pays: P1 = P0 (no change) Seller receives: P1 - 10 = P0 - 10 (Full incidence) Intuition Perfectly Inelastic DD: 1. Buyers completely unresponsive to changes in price 2. Full burden (incidence) of tax is borne by buyers Perfectly Elastic DD: 1. Buyers very responsive to change in price (quantity demanded falls to zero for any increase in price) 2. Full bürden (incidence) of tax is borne by sellers Incidence of 10% Sales Tax Buyers pays: No Tax (Infinitely Elastic DD) All Tax (Infinitely Inelastic DD) Some of Tax (Usual Case) Student Exercise: What is incidence (burden) of sales tax if: 1. SS is perfectly Inelastic 2. SS is perfectly Elastic Consumer Demand Theory Theory of Consumer Choice (used to derive Law of Downward-Sloping Demand) 2nd year: Indifference Curves 1st Year: Utility Theory (this section) Refer to page 468 for utility theory Principle of Diminishing Marginal Utility Total Utility = Total satisfaction to person from consumption of product Marginal Utility = Additional satisfaction (change in total utility) from consumption of one more unit of product Principle of Diminishing Marginal Utility As a person consumes more of a good, the marginal utility of the good declines NUMERICAL EXAMPLE Total Utility Marginal Utility Movies Per Month (TU) (MU) 0 0 - 1 30 30 2 50 20 3 65 15 4 75 10 5
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