Taxes & Market Equilibrium Chapter 6

How Taxes on Buyers (and Sellers) Affect Market Outcomes When a good is taxed, the quantity sold is smaller Buyers and sellers both share the tax burden Types of Taxes: Sales Tax: tax on most goods (usually % of price) Excise Tax: taxes on specific goods (ex: cigarettes, gasoline, etc…) Why tax? To raise Government Revenue or To decrease consumption of a good (cigarettes) 22 30

Elasticity & Tax Incidence Tax incidence is the study of who bears the burden of a tax Taxes always result in a change in market equilibrium Buyers pay more & sellers receive less regardless of whom the tax is levied on! 21 31

Example: Tax on Sellers Government places a tax on ice cream of .50 cents Does the tax shift the supply or demand curve? Demand Curve is not affected Determinant of demand did not change (TIPSEN ) Supply Curve will shift left Taxes is a determinant of supply (TINE & TP)

Tax on Sellers Price of Ice-Cream Demand, D1 Price buyers pay Cone S2 A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). Price buyers pay Cone S2 Equilibrium with tax S1 $3.30 90 Tax ($0.50) TINE & TP Taxes are a Determinant of supply Price without tax 3.00 100 Equilibrium without tax 2.80 Price sellers receive Quantity of Ice-Cream Cones

Tax on Buyers Price of Ice-Cream Price buyers pay Supply, S1 Cone D1 $3.30 90 Equilibrium without tax Tax ($0.50) Price without tax 3.00 100 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). 2.80 New Equilibrium with tax Price sellers receive Quantity of Ice-Cream Cones

Elasticity determines 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? It depends on the elasticity of demand & the elasticity of supply 29 39

Inelastic Demand (a) Inelastic Demand, Elastic Supply Price 1. When supply is more elastic than demand . . . Demand Price buyers pay Tax 2. . . . the incidence of the tax falls more heavily on consumers . . . Supply Price without tax 3. . . . than on producers. Price sellers receive Quantity

Inelastic Supply (b) Inelastic Supply, Elastic Demand Price 1. When demand is more elastic than supply . . . Demand Price buyers pay Supply Tax 3. . . . than on consumers. Price without tax 2. . . . the incidence of the tax falls more heavily on producers . . . Price sellers receive Quantity

So, how is the burden of the tax divided? The burden of a tax falls more heavily on the side that is less elastic D S The Steeper Curve pays more tax! 30 41

Tax Summary A tax on buyers shifts D-curve A tax on sellers shifts S-Curve The incidence of a tax does not depend on whether the tax is levied on buyers or sellers It depends on the price elasticities of supply and demand. The majority of the tax burden falls on the side of the market that is less elastic (more inelastic, steeper curve pays more of tax)

Worksheet on Excise Taxes Lesson 4, Activity 21

Perfectly Inelastic Demand ---------- Tax Revenue Tax ----------- P1 Q1