1. The Effects of a Tax... Supply Demand Price Size of tax per unit
Price buyers pay
Size of tax per unit
Quantity with tax
Price without tax
Quantity without tax
Price sellers receive
Demand
Quantity 9

2. The Effects of a Tax
A tax places a wedge between the price buyers pay and the price sellers receive.
Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax. 9

3. Tax Revenue... Supply Demand Price Tax Revenue (T x Q)
Size of tax per unit (T)
Price buyers pay
Tax Revenue (T x Q)
Price sellers receive
Quantity sold (Q)
Demand
Quantity with tax
Quantity without tax
Quantity 9

4. How a Tax Affects Welfare...
Tax reduces consumer surplus by (B+C) and producer surplus by (D+E)
Price
Price
buyers
pay = PB
Tax revenue = (B+D) A B C F D E
Supply P1
Price without tax =
Deadweight Loss = (C+E) PS
Price sellers receive =
Demand Q2 Q1
Quantity 14

5. Changes in Welfare from a Tax
Without Tax
With Tax
Change
Consumer Surplus
A + B + C A
- (B + C)
Producer Surplus
D + E + F F
- (D + E)
Tax Revenue
none
B + D
+ (B + D)
Total Surplus
A + B + C + D + E + F
A + B + D + F
- (C + E )
The area C+E shows the fall in total surplus and is the deadweight loss of the tax.

6. How a Tax Affects Welfare
The change in total welfare includes:
The change in consumer surplus,
The change in producer surplus,
The change in tax revenue.
The losses to buyers and sellers exceed the revenue raised by the government.
This fall in total surplus is called the deadweight loss. 14

7. Deadweight Losses and the Gains from Trade
Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade. 39 68

8. The Deadweight Loss... Supply PB PS Demand Q2 Q1 Price
Lost gains from trade
Supply PB
Size of tax
Price = P1
without tax PS
Cost to sellers
Demand
Value to buyers Q2 Q1
Quantity
Reduction in quantity due to the tax 14

9. Determinants of Deadweight Loss
The magnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price.
That, in turn, depends on the price elasticities of supply and demand. 21

10. P P S S D1 D2 Q Q P S D2 D1 Q T T ΔQ ΔQ When demand is
Pg1
Pn1 Q1 P Q S P0 Q0 D2
Pg2
Pn2 Q2 T ΔQ T ΔQ
When demand is
relatively inelastic,
the deadweight loss
of a tax is smaller. P Q D1 S P0 Q0 D2
Pg1
Pn1 Q1
Pg2
Pn2 Q2
When demand is
relatively more elastic,
the deadweight loss
of a tax is larger.

11. P Q D S1 P Q D S2 P Q D S1 S2 T ΔQ T ΔQ When supply is
Pg1
Pn1 Q1 P Q D P0 Q0 S2 Q2
Pg2
Pn2 T ΔQ T ΔQ
When supply is
relatively inelastic,
the deadweight loss
of a tax is smaller. P Q D S1 P0 Q0
Pg1
Pn1 Q1 S2 Q2
Pg2
Pn2
When supply is
relatively elastic,
the deadweight loss
of a tax is larger.

12. Determinants of Deadweight Loss
The greater the elasticities of demand and supply:
the larger will be the decline in equilibrium quantity and,
the greater the deadweight loss of a tax. 22

13. Relationship between the tax revenue collected
and the price elasticity of demand
tax revenue:
T • Q1
tax revenue:
T • Q2 P Q D1 S P0 Q0 D2
Pg1
Pn1 Q1
Pg2
Pn2 Q2
For a given equilibrium quantity prior to the introduction of a tax (e.g., Q0), the tax revenue collected from the tax will be larger as the price elasticity of demand is smaller.

14. Relationship between the tax revenue collected
and the price elasticity of supply
tax revenue:
T • Q1 P Q D S1 P0 Q0
Pg1
Pn1 Q1 S2 Q2
Pg2
Pn2
tax revenue:
T • Q2
For a given equilibrium quantity prior to the introduction of a tax (e.g., Q0), the tax revenue collected from the tax will be larger as the price elasticity of supply is smaller.

15. Deadweight Loss and Tax Revenue...
(a) Small Tax
Price
Supply
Deadweight
loss PB
Tax revenue PS
Demand Q2 Q1
Quantity 31

16. Deadweight Loss and Tax Revenue...
(b) Medium Tax
Price
Supply
Deadweight
loss PB
Tax
revenue PS
Demand Q2 Q1
Quantity 31

17. Deadweight Loss and Tax Revenue...
(c) Large Tax
Price
Supply PB
Tax revenue
Deadweight
loss
Demand PS Q2 Q1
Quantity 31

18. Deadweight Loss and Tax Revenue
For the small tax, tax revenue is small.
As the size of the tax rises, tax revenue grows.
But as the size of the tax continues to rise, tax revenue falls because the higher tax reduces the size of the market.