Supply, Demand and Government Policies Chapter 6 Copyright © 2001 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida

Taxes Governments levy taxes to raise revenue for public projects.

What are some potential impacts of taxes? u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Buyers and sellers share the tax burden.

Taxes u Tax incidence is the study of who bears the burden of a tax. u Taxes result in a change in market equilibrium. u Buyers pay more and sellers receive less, regardless of whom the tax is levied on.

Impact of a 50¢ Tax Levied on Buyers Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 100 D1D1 Supply, S 1 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). D2D2 Copyright © 2001 by Harcourt, Inc. All rights reserved

3.00 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone $3.30 Price buyers pay D1D1 D2D2 Equilibrium with tax Supply, S 1 Equilibrium without tax Impact of a 50¢ Tax Levied on Buyers Price sellers receive Copyright © 2001 by Harcourt, Inc. All rights reserved Price without tax Tax ($0.50)

What was the impact of tax? u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Buyers and sellers share the tax burden.

3.00 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone S1S1 S2S2 Demand, D 1 Impact of a 50¢ Tax on Sellers... Price without tax 2.80 Price sellers receive $3.30 Price buyers pay Equilibrium without tax Copyright © 2001 by Harcourt, Inc. All rights reserved A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). Tax ($0.50) Equilibrium with tax

Impact of Taxes Tax Wedges  Taxes on buyers and taxes on sellers are equivalent.  Taxes place a wedge between what the sellers receive and what the buyer pays.  The wedge shifts the relative position of the supply and demand curve so that buyers and sellers share the burden of the tax.

The Incidence of Tax u In what proportions is the burden of the tax divided? u 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.

Elastic Supply, Inelastic Demand... Quantity0 Price Demand Supply Tax 1. When supply is more elastic than demand the incidence of the tax falls more heavily on consumers than on producers. Price without tax Price buyers pay Price sellers receive

Inelastic Supply, Elastic Demand... Quantity0 Price Demand Supply Price without tax Tax 1. When demand is more elastic than supply the incidence of the tax falls more heavily on producers than on consumers. Price buyers pay Price sellers receive

So, how is the burden of the tax divided? The burden of a tax falls more heavily on the side of the market that is less elastic.