TAXES!

Why do I tax all the time?

How Taxes Affect Market Outcomes

• Market not efficient– Total surplus not maximized

• When a good is taxed, the quantity sold is smaller.

• Buyers and sellers share the tax burden.

Tax incidence

• When the burden of a tax is shared among participants in a market

If there is a sales tax on buying these candy worms, it’s not just the kid with worms

who feels the burden of the tax

Price Qd Qs$1 50 10$2 40 20$3 30 30$4 20 40$5 10 50

CANDY WORM MARKET

Let’s say there is a $0.50 tax on buying candy worms

3 questions must be answered to figure out the tax incidence

Question 1: Does the tax affect the supply curve or the demand curve?

Question 2: Which way does the curve shift?

Question 3: How does the shift affect equilibrium?

S1

What happens if there is a $0.50 tax on the buyer?

D1

P

Q

Your turn

3 questions must be answered to figure out the tax incidence

Question 1: Does the tax affect the supply curve or the demand curve?

Question 2: Which way does the curve shift?

Question 3: How does the shift affect equilibrium?

Assume the government wants to reduce the amount of sugar Americans are consuming. So, they enforce a

excise tax of $1.00 for every candy worm produced.

S1

What happens if there is a $0.50 tax on the seller?

D1

P

Q

Elasticity and Tax Incidence

• In what proportions is the burden of the tax divided?

• How do the effects of taxes on sellers compare to those levied on buyers?

• The answers to these questions depend on the elasticity of demand and the elasticity of supply.

How the Burden of a Tax Is Divided

Quantity0

Price

Demand

Supply

Tax

Price sellersreceive

Price buyers pay

(a) Elastic Supply, Inelastic Demand

2. . . . theincidence of thetax falls moreheavily onconsumers . . .

1. When supply is more elasticthan demand . . .

Price without tax

3. . . . than on producers.

How the Burden of a Tax Is Divided

Quantity0

Price

Demand

Supply

Tax

Price sellersreceive

Price buyers pay

(b) Inelastic Supply, Elastic Demand

3. . . . than onconsumers.

1. When demand is more elasticthan supply . . .

Price without tax

2. . . . theincidence of the tax falls more heavily on producers . . .

Your turn…again

Luxury Tax

Luxury Tax

• In 1990, Congress adopted a new luxury tax on items that only the rich could afford. The goal of this tax is to raise revenue from those who could easily afford to pay

• Answer this question: Does the price incidence truly affect buyers more?

• Write a short answer and provide a supply and demand curve to further explain your answer.