11.1. Meaning ?  If you have a lunch in a restaurant and your bill includes with some tax, does it mean that the charged tax is paid all by yourself?  Answer: It may not. You may share the paid tax with the restaurant’s owner  Tax incidence  Who does really pay the tax charged on goods, such as a lunch that you eat in the restaurant ?  Consumer, or producer or both

11.2. Tax Incidence in Competitive Markets

 Effect of Tax at Firm Level Po PriceS1 So Tax rate t q1 qo  Tax  Makes a firm reducing its production from qo to q1 Quantity

 Effect of Tax at Market Level Po PriceS1 So Tax rate t Q1 Qo  Tax  Makes price increasing from Po to P1, and transaction decline from Qo to Q1 Po + t P1 Quantity

 Tax Incidence: Who Pay for Tax Po PriceS1 So Tax rate t Q1 Qo  Tax  causes price increases from Po to P1, and transaction declines from Qo to Q1  Consumer’ tax contribution P1-P2  Producer’s tax (P1-P2) P2 P1 Quantity

Po Price D1 Do So Pajak t Q1 Qo  Tax levied on consumer  Makes demand shifting from Do ke D1, and transaction declines from Qo to Q1  Consumer pays old price P2 and tax rate t  Price becomes P1  Consumer’s share on tax = P1 – Po  Producer’s share (Po-P2) P2 P1  No Matters Whether Tax is Levied on Consumers or Producer Quantity

11.3. Ad valorem Tax versus SpecificTax  Ad valorem tax  Tax whose rate is percentage of price  For instance, t = 20 % of P  Specific tax  Tax whose rate is a fixed amount per unit of product (t)  For instance, t = Rp 500 / kg

Po Price D1 Do So Specific tax, Rp t per Kg Q1 Qo P1  Effect of Ad Valorem Tax versus Effect Specific Tax: Same on revenue and output D3 Tax rate: c % dari harga P2= Po + tax Quantity

11.4. Effect of Elasticity on Tax Incidence

Po Price Do So Tax rate t Q1 Qo P1  If Demand is perfectly Inelastic, all tax is born By consumer S1 Quantity

Po Harga Do So Pajak t Q1 Qo P1  If Supply is perfectly elastic, all tax is born by consumer S1

Price Do Qo=Q1 Po=P1  If Supply perfectly Inelastic, all tax is born by producer S  Supply curve before and after tax Quantity

Price Do Tax t Q1 Qo Po=P1  If demand is perfectly elastic, all tax is born Producer S1 Quantity S0

11.5. Tax Incidence on Wages  Levying tax on wages will reduce demand for labor by firm  Since, the tax will cause production cost increase

 Analyzing Tax Incidence on Wages and Labor Demand S D1 Do W1 Wo Wages Labor Tax L1 L0 Wo + tax Tax born by laborer Tax borne by firm

11.6. Readings Stiglitz, Joseph E Economics of the Public Sector. New York, USA: W.W. Northon and Company (Chapter 18)