1. Tax Incidence
Ap micro 9/21

2. Warm Up

3. Tax Burdens Who bears the burden of taxation?
Depends on elasticity
When the price elasticity of demand is higher than the price elasticity of supply, excise tax falls mostly on producers
When the price elasticity of supply is higher than the price elasticity of demand, excise tax falls mostly on consumers.
The amount of efficiency loss also depends on elasticity
The greater the elasticities of supply and demand, the greater the efficiency loss

4. Excise Tax Paid Mostly by Consumers
Price of gas (per pound)
When the price elasticity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls mainly on consumers.
$2.95
Tax burden falls mainly on consumers
Excise tax = $1 per gallon
2.00 S
1.95 D
Quantity of gasoline (pounds)

5. Excise Tax Paid Mainly by Producers
Price of gas (per pound)
When the price elasticity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls mainly on consumers.
$2.95
Tax burden falls mainly on consumers
Excise tax = $1 per gallon
2.00 S
1.95 D
Quantity of gasoline (pounds)

6. Tax Burden

7. Taxes Reduces Consumer and Producer Surplusi c e
Fall in consumer surplus due to tax S CS P C
Tax paid by consumer
Excise tax = T P
DWL E E
Tax paid by Producer
Fall in producer surplus due to tax P P PS D Q Q T E
Quantity

8. DWL and Demand Elasticity
(a) Elastic Demand
(b)
Inelastic Demand
Price
Price S S
Deadweight loss is larger when demand is elastic P C
Excise tax = T P C E
Deadweight loss is smaller when demand is inelastic P P E E E
Excise tax = T P P D P P D Q Q
Quantity Q Q
Quantity T E T E

9. DWL and Supply Elasticity
(c) Elastic Supply
(d)
Inelastic Supply
Price
Price S
Deadweight loss is larger when supply is elastic P C S P
Excise tax = T C P P E
Deadweight loss is smaller when supply is inelastic E E
Excise tax = T E P P P P D D Q Q
Quantity Q Q
Quantity T E T E

10. DWL and Elasticity
To minimize the efficiency costs of taxation, one should choose to tax only those goods for which demand or supply, or both, is relatively inelastic.
For such goods, a tax has little effect on behavior because behavior is relatively unresponsive to changes in the price.

11. Practice Problems
1. All states impose excise taxes on gasoline. According to data from the Federal Highway Administration, the state of California imposes an excise tax of $0.18 per gallon of gasoline. In 2005, gasoline sales in California totaled 15.6 billion gallons.
a. What was California’s tax revenue from the gasoline excise tax?
b. If California doubled the excise tax, would tax revenue double? Why or why not?

12. 2. Under the conditions created by the $60 per car tax…
Price
Quantity Supplied
Quantity Demanded
$100
1000 90
900
100 80
800
200 70
700
300 60
600
400 50
500 40 30 20 10
2. Under the conditions created by the $60 per car tax…
a. Calculate consumer surplus. (Wait: what method should be used? Look at what this problem involved.)
b. Calculate producer surplus.
c. Determine the elasticity of demand when the price of rental cars increased from $60 to $80. Is demand for rental cars in this range elastic, inelastic, or unit elastic?