Oct 17, 2011
Economics – Textbook Notes
Everything you earn and almost everything you buy is taxed.
Tax incidence is the division of the burden of a tax between buyers and sellers.
The price paid by buyers might rise by the full amount of the tax, then the burden
of the tax falls entirely on buyers – the buyers pay the tax
The price paid by buyers might rise by a lesser amount than the tax, then the
burden of the tax falls partly on buyers and partly on sellers
The price paid by buyers might not change at all, then the burden of the tax falls
entirely on sellers
Tax on Sellers
A tax on sellers is like an increase in cot, so it decreases supply. To determine the
position of the new supply curve, we add the tax to the minimum price that sellers are
willing to accept for each quantity sold.
Tax on Buyers
A tax on buyers lower the amount there are willing to pay sellers, so it decreases demand
and shirts the demand curve leftwards. To determine the position of this new demand
curve, we subtract the tax from the maximum price that buyers are willing to pay for each
Equivalence of Tax on Buyers and Sellers
Can we Share the Burden Equally?
o The tax had the same effect regardless of whether it is imposed on sellers
or buyers, So imposing half the tax on one and half on the other is like an
o When a transaction is taxed, there are two prices: the price paid by the
buyer, which includes tax; and the price received by sellers, which
excludes the tax.
Buyers respond to the price that includes the tax
Sellers respond to the price that excludes the tax
The Employment Insurance Tax
o The Employment Insurance Tax is an example of a tax that the federal
government imposes on both buyers of labour (employers) and sellers of
o The division of the burden of a tax between buyers and sellers depends on
the elasticity of demand and supply
Tax Incidence and Elasticity of Demand
The division of the tax between buyers and sellers depends in part on the elasticity of
demand. Nicole Wallenburg
Oct 17, 2011
Perfectly Inelastic Demand Buyer pays
Perfectly Elastic Demand Seller pays
The more inelastic the demand, the larger is the amount of the tax by buyers
Tax Incidence and Elasticity of Supply
The division of the tax between buyers and sellers also depends, in part, on the elasticity
Perfectly Inelastic Supply Sellers pay
Perfectly Elastic Supply Buyers pay
How the tax is split depends on the elasticity of supply: The more elastic the supply, the
larger is the amount of the tax paid by buyers.
Taxes and Efficiency
A tax drives a wedge between the buying price and the selling price and results n
The price buyers pay is also the buyers’ marginal social benefit
The price the sellers receive is also the sellers’ minimum supply-price, which
equals marginal social cost
A tax makes marginal social benefit exceed marginal social cost, shrinks the producer
surplus and consumer surplus, and creates a deadweight loss.
Taxes and Fairness
Economists have proposed two conflicting principles of fairness to apply to a tax system:
The Benefits Principle
o The proposition that people should pay taxes equal to the benefits they
receive from the services provided by governments.
The Ability to Pay Principle
o The proposition that people should pay taxes according to how easily they
can bear the burden of the tax.
Production Quotas and Subsidies
Governments often use two methods of intervention in the markets for farm products.
A production quota is an upper limit to the quantity of a good that may be produced in a
If governments introduced a production quota above the equilibrium quantity, not would
change because farmers would already be producing less than the quota
If governments introduced a production quota below the equilibrium quantity, it has big
effects, such as:
Decrease in Su