Application: The Costs Of Taxes
Examine how taxes reduce consumer and producer surplus.
Learn the meaning and causes of the deadweight loss of a tax.
Consider why some taxes have larger deadweight losses than others.
Examine how tax revenue and deadweight loss vary with the size of a tax.
A Tax on a good reduces the welfare of buyers and sellers of the good, and the reduction in consumer and
producer surplus usually exceeds the revenue raised by the gov't.
The fall in total surplus is called the DEADWEIGHT LOSS OF THE TAX.
Taxes have deadweight losses because they cause buyers to consume less and sellers to produce less, and
this change in behaviour shrinks the size of the market below the level max total surplus.
Larger elasticises imply larger deadweight losses.
As tax grows, it distorts incentives more and its deadweight loss grown larger. Tax revenue first rises with
he size of a tax. Eventually, larger the tax reduces tax revenue because it reduces size of market.
Govt can sometimes improve market outcomes. (Taxes)
The Deadweight Loss of Taxes
simplify graphs by not shifting the graphs:
Tax places WEDGES between price buyers and price sellers receive.
Tax wedge: Quantity sold falls below the level that would be sold without a tax. TAX ON GOOD
CAUSES THE SIZE OF THE MARKET FOR TH GOOD TO SRHINK.
How tax affects market Participants
Tools of welfare: measure gain