ECON 1110 Chapter Notes - Chapter 7: Deadweight Loss, Tax Wedge, My5
12 Jan 2017
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Friday, September 30, 2016
Chapter 7: Taxes
1. Taxes are necessary: all governments need money to function
a. Taxes have a cost that normally exceeds the money actually paid to the
government
b. Prevent mutually beneficial transactions from occurring
i. Creates a deadweight loss
c. If either supply or demand were perfectly inelastic, then tax would not discourage
transactions and there would be no deadweight loss
d. In order to minimize the efficiency costs of taxation, the demand, supply, or both
for a good should be inelastic
2. Tax policy must strike a balance between efficiency and fairness
3. Excise Tax: A tax on sales of a good or service
a. Creates inefficiency by distorting incentives and creating missed opportunities
b. Relatively minor source of government revenue
4. Incidence of a Tax: A measure of who really pays a tax
a. Producers and consumers often split the tax unevenly
b. The incidence of an excise tax depends on the price elasticity of supply and the
price elasticity of demand
5. When the price elasticity of demand is low and the price elasticity of supply is high, the
burden of an excise tax falls mainly on consumers
a. A low price elasticity of demand means that consumers have few substitutes and
little alternative to buying the good
b. The party with the least flexibility gets stuck paying most of the tax
6. When the price elasticity of demand is high and the price elasticity of supply is low, the
burden of an excise tax falls mainly on producers
7. The revenue collected by an excise tax is equal to the area of the rectangle whose
height is the tax wedge between the supply and demand curves and whose width is the
quantity transacted under the tax
8. Tax Rate: Amount of tax people are required to pay per unit of whatever is being taxed
9. If the price elasticities of both supply and demand are low, the tax increase won’t reduce
the quantity of the good sold very much, so tax revenue will rise
10. Sin Tax: Tax created to discourage undesirable behavior
11. Administrative Costs of a Tax: Resources used (which is a cost) by government to
collect the tax, and by taxpayers to pay it, over and above the amount of tax, as well as
to evade it
a. Society ultimately pays the administrative costs of taxes
12. The total inefficiency caused by a tax is the sum of the deadweight loss and the
administrative costs
13. The larger the number of transactions prevented by a tax, the larger the deadweight loss
14. When either demand or supply is elastic, there will be a large decrease in the quantity
demanded and a large deadweight loss
15. When either demand or supply is inelastic, the quantity demanded or quantity supplied is
unresponsive to the changes in price and there will be a small deadweight loss
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