1. Taxes & Subsidies Economic Welfare Supplement

2. How Do We Analyze the Effects of Taxes and Subsidies
The efficient ideal market
“perfectly competitive” market
Consumers and suppliers are price-takers, i.e. have no market power

3. Total Social Welfare
Ideally the impact of a program should be evaluated as: {Pareto efficient}
1) can at least one person’s welfare be improved
2) without making anyone worse off
More realistically: Could the winners compensate the losers? {Pigouvian}
Is the deadweight loss of the taxed good less than the surplus gain from the subsidized good?

4. Deadweight Loss Price Consumers Pay Pre-tax price Price Sellers
Receive
Reduction in
Qty sold

5. Deadweight Loss Retained CS Tax Rev From CS Tax Rev From CS
Retained PS

6. How Do We Evaluate the Impact of the Tax?
Two Parts:
Tax Incidence
Who pays for it more?
Consumers or Producers?
Will depend on relative demand/supply elasticities
Economic welfare analysis
Does the tax (revenue) improve social welfare?
Will depend on relative elasticities of:
a) good taxed
B) good or program financed by the tax

7. What Are the Benefits? Depends on what we do with the taxes
Suppose we use it to subsidize another good
Subsidy appears as a reduction in per-unit costs to the firm getting the subsidy

8. Evaluating The Impact Costs: Benefits Will Benefits > Tax
Deadweight loss: sum of reduction in consumer and producer surplus for the taxed good
Reflects reduction in Qd and higher price paid
Benefits
Gain in CS and PS from subsidized cost
Will Benefits > Tax
Depends on the relative demand elasticities for the 2 goods

9. Evaluating the Impact
“A Positive Analysis” (Distributional Consequences)
Who gains/loses from the tax and subsidy?
Both producers and consumers of the taxed good lose (in terms of lost surpluses)
Relative demand/elasticities determine who loses most
More inelastic demand -> greater is CS loss
Producers and Consumers of subsidized good win (lower price and more Q)
Relative demand supply elasticities determine who benefits most

10. Total Social Welfare
Ideally the impact of a program should be evaluated as: {Pareto efficient}
1) can any one (or more) person’s welfare be improved
2) without any one else’s welfare being reduced
More realistically: Could the winners compensate the losers? {Pigouvian}
Is the deadweight loss of the taxed good less than the surplus gain from the subsidized good?