Ec 10a – Chapter 8 09/25/2013
Application: The Costs of Taxation
Tax Wedge – gap forced between the price buyers pay and the price sellers receive, due to taxes
Taxes cause quantity sold to decline, causing the size of the market for a good to
T=size of tax
Q=quantity of good sold
Government takes in T x Q; the rectangle of the tax wedge
Deadweight loss – the fall in total surplus that results from a market distortion, such as a tax
Because the fall in producer and consumer surplus exceeds tax revenue, the tax is said to impose a
deadweight loss (area C+E)
Joe agrees to clean Jane’s house for $100. Joe would do it for at least $80, and Jane would pay at most
Government imposes $50 tax.
Either scenario, one or the other would be losing $10, and thus the deal does not happen.
As a result, the government does not make any money, Joe makes no income, and Jane has a dirty house.
The tax has made Joe and Jane worse off by $40, $20 surplus each. The $40 is pure deadweight loss Deadweight loss – A loss to buyers and sellers that is not offset by an increase in government revenue