1. Elasticity & Deadweight Loss
How large is the loss to society of taxes?
Chapter 8

2. Taxes
When a good is taxed => Buyers & sellers both bear some of the tax burden
2 Types of Taxes:
Sales Tax: % tax on most goods
8.0% in California
Excise Tax: per unit taxes on specific goods (ex: cigarettes, gasoline, etc…)
$0.50 per gallon of gas, $2.87 per pack of cigarettes (California)
2 Reasons to Tax:
To ↑ Government Revenue and/or
To ↓ Consumption of a good (negative externalities, i.e. cigarettes) 22 30

3. Excise Tax Per pack of Cigarettes
New York 1st = $4.35 per pack
Missouri last =   $0.18
California 8th = $2.87
Elasticity?
Px ↑ 10% => Qty D ↓ 4%
Ed = 0.4 is inelastic
Taxing cigarettes the “correct amount” will not cause DWL => Smoking is considered a negative externality. (mkt failure)

4. DETERMINANTS OF DEADWEIGHT LOSS
The magnitude of deadweight loss depends on how much the quantity supplied & quantity demanded change
i.e. how much does the market shrink with a tax
Magnitude of changes in quantity supplied/demanded, in turn, depend on the price elasticities of supply and demand

5. Tax & DWL Summary
Taxes cause DWL because the size of a market shrinks (Qty ↓)
Elastic curves => lead to a larger ↓ Qty from a tax => therefore: DWL is large & Tax Revenue small
Inelastic curves => lead to a smaller ↓ Qty from a tax => therefore: DWL is small & Tax Revenue is large
Inelastic Demand
Elastic Demand

6. DWL, Tax Revenue &Elasticity
Elastic Supply
Inelastic Supply
Inelastic Demand
ELASTIC = LARGE deadweight loss
Small Tax Revenue
INELASTIC = SMALL deadweight loss
Large Tax Revenue
Elastic Demand

7. Worksheet: Excise Taxes & Deadweight Loss
Price
T-Shirts
$20 S1
$10 E1 D1
2,000
Qty