Excise Taxes, Subsidies, & Trade Barriers AP Microeconomics Unit 2, Days 4 & 5 Stater

Excise Taxes Part 1

Excise tax A per-unit tax on the production of a good, imposed by the government for one of two reasons: To increase government revenue To decrease consumption of a harmful good Examples? ***Shifts the SUPPLY curve vertically by the tax amount (technically it is a shift left, as it is a decrease in supply)***

Government Revenue Results whenever an excise tax (including tariffs) is applied to a good. Calculated by multiplying the amount of the tax times the NEW quantity (Tax x Q) Gov’t revenue is bigger the more inelastic the demand

Relationship between elasticity of demand and excise taxes The more inelastic the demand, the: Larger the gov’t revenue; Smaller the decrease in consumption. The more elastic the demand, the: Smaller the gov’t revenue; Larger the decrease in consumption.

Tax Incidence - Burden on consumers or producers? The more elastic the demand OR the more inelastic the supply: The more the incidence falls on producers, because they are less equipped to respond. The more inelastic the demand OR the more elastic the supply: The more the incidence (or burden) falls on consumers, because they are less equipped to respond.

Excise Tax Practice Problem Copy the graph. Label the equilibrium price & quantity. Assume there is a $3.00 excise tax imposed on this good. Shift the supply curve accordingly & label it ST. Label the new price & quantity. What happened to each? Label the rectangle that represents government revenue, and calculate. Label consumer surplus, producer surplus, & the DWL triangle, and calculate.

Excise Tax Practice Problem

S + tax CS Gov’t Tax Revenue DWL PS

Add-on Question to graph (to come back to after finishing notes) If the demand curve were more inelastic, would the government revenue increase or decrease? Would consumption decrease more or less drastically? Would the tax incidence shift more toward consumers or producers?

Perfectly Inelastic Demand Ed = 0 Revenue Largest government revenue No effect on quantity demanded (no decrease in consumption) Consumers pay for the tax by paying a higher price

Perfectly Elastic Demand Ed = infinity Smallest government revenue Largest effect on quantity demanded (decrease in consumption!) Producers pay for the tax Revenue

Deadweight Loss (DWL) DWL Net benefit lost by society caused by a movement away from market equilibrium Excise taxes result in DWL. Represented by a triangle on the graph. It USED to be consumer & producer surplus! (when the market was in equilibrium) DWL

Subsidies & Trade Barriers Part 2

Group questions – Part 1 (5 minutes) A subsidy is a payment made by the government to a firm for its production of a certain product or service. Why do you think the government would ever subsidize a product? In contrast to an excise tax, how would a subsidy affect the production cost of good X? How will a subsidy shift the supply curve of good X? Demonstrate on a graph. What will happen to the equilibrium price and quantity of good X?

Imports & Trade barriers: Definitions (Add these to notes!) Import: Any good produced abroad but consumed domestically Revenue tariff: an excise tax levied on an import that is NOT produced in the domestic market (ex: bananas) Protective tariff: an excise tax levied on an import that IS produced in the domestic market (ex: steel) Import quota: a maximum amount of a good that can be imported into the domestic market

Class discussion questions (5 minutes) Using the definitions of the various trade barriers, answer the following: What do you think is the primary purpose of a revenue tariff? Why would we want to import goods that are already being made in our country? What do you think may be the purpose of a protective tariff? What do you think is an important distinction between tariffs and quotas? What might be some negative effects of both?

Effects of a Tariff on the domestic market https://www. youtube Identify the following: Consumer surplus (use letters) – before and after the tariff Producer surplus (use letters) – before and after the tariff Government tax revenue (use letters) Deadweight loss (use letters) resulting from the tariff