2. Taxes, trade, & welfareslide 1 Taxes and Welfare In this section, we examine the effects on welfare of changes in excise taxes. The approach taken here, is to use the devices of Producer and Consumer Surplus. The social welfare from the production and consumption of a particular amount of a good is the sum of the producer surplus, consumer surplus, and any tax revenue taken in by the government.

3. Taxes, trade, & welfareslide 2 S D Q P Q* P* What are the welfare effects of an excise tax on beer? BEER MARKET

4. Taxes, trade, & welfareslide 3 d D Q P Q* P* CHANGE IN CS = -a - b CHANGE IN PS = -c - d TAX REVENUE OF GOV'T = a + c So social cost = b + d BEER MARKET S + t TAX PER UNIT b a c S

5. Taxes, trade, & welfareslide 4 Economists call the loss in social welfare due to the tax THE DEADWEIGHT LOSS from the tax.

6. Taxes, trade, & welfareslide 5 Illustrating the deadweight loss The following hidden slide shows the changes in surplus and the deadweight loss due to an excise tax. Hidden slide

7. Taxes, trade, & welfareslide 6 What happens to welfare when an excise tax is put on a good? D Q0Q0 S D Q0Q0 S PP Q Q P' Starting consumer surplus Starting producer surplus New consumer surplus New producer surplus S + t P' - t Tax revenueDeadweight loss

8. Taxes, trade, & welfareslide 7 The size of the deadweight loss is determined by 1) The elasticity of the demand curve. 2) The elasticity of the supply curve. 3) The amount of the tax per unit.

9. Taxes, trade, & welfareslide 8 The following hidden slide shows the effect of demand elasticity on the size of the deadweight loss in welfare due to an excise tax. Hidden slide

10. Taxes, trade, & welfareslide 9 S D elast D inelast S Q Q $/Q Equal Pretax Sales The more elastic the demand curve, the greater is the deadweight loss. S+Tax Larger deadweight loss Smaller deadweight loss

11. Taxes, trade, & welfareslide 10 Economists use terms such as "distortion of the market" to describe the loss. The deadweight loss is an example of an economic inefficiency.

12. Taxes, trade, & welfareslide 11 The following hidden slide shows the effect of supply elasticity on the deadweight loss due to a tax. Hidden slide

13. Taxes, trade, & welfareslide 12 S inelas D D S elas Q Q $/Q Equal Pretax Sales The more elastic the supply curve, the greater is the deadweight loss. S inelas +Tax S elas +Tax Larger deadweight loss Smaller deadweight loss

14. The following hidden slide shows the effect of demand elasticity on the government’s tax revenue. Hidden slide

15. Taxes, trade, & welfareslide 14 S D elast D inelast S Q Q $/Q Equal Pretax Sales The more elastic the demand curve, the smaller is tax revenue. S+Tax Larger tax revenue Smaller tax revenue

16. Taxes, trade, & welfareslide 15 Notice that this analysis can also be applied to subsidies: A per unit subsidy will create a DEADWEIGHT LOSS in social welfare. In the case of the subsidy too much of society's resources will be devoted to the good.

17. Taxes, trade, & welfareslide 16 Trade and Welfare In this section, we examine the effects on welfare of international trade. The approach taken here, is to use the devices of Producer and Consumer Surplus. The change in social welfare when trade is allowed can be measured by the changes in producer and consumer surplus.

18. Taxes, trade, & welfareslide 17 S D Q P Q* P* = $10 The diagram below shows the U.S. domestic market for wine. No trade is taking place. WINE MARKET

19. Taxes, trade, & welfareslide 18 In the case of wine, let's suppose the world price is lower than the U.S no-trade price, say, $8.00 per bottle.

20. Taxes, trade, & welfareslide 19 S D Q P Q* P* = $10 What happens with trade? What are the welfare effects of trade? WINE MARKET P* = $8 Q"Q'

21. Taxes, trade, & welfareslide 20 S D Q P P* = $10 U.S. consumers gain b + d. U.S. producers lose b. Welfare rises by d. WINE MARKET P* = $8 Q"Q' d c b a

22. The next (hidden) slide shows in a dynamic way who gains from trade when the world price is below the domestic, no trade price. Hidden slide

23. Taxes, trade, & welfareslide 22 D Q Q $/Q Welfare changes due to imports of wine D Q $/Q S S No trade CS No trade PS World price Imports Gain in surplus New CS New PS

24. Taxes, trade, & welfareslide 23 S D Q P Q* P* = $1500 The diagram below shows the U.S. domestic market for computers. No trade is taking place. COMPUTER MARKET

25. Taxes, trade, & welfareslide 24 Suppose computers can be sold for $2000 each on the world market and trade is allowed. What happens with trade? What are the welfare effects of trade?

26. Taxes, trade, & welfareslide 25 S D Q P Q* P* = $1500 U.S. consumers lose b. U.S. producers gain b + d. Welfare rises by d. COMPUTER MARKET P* = $2000 a b c d

27. The next (hidden) slide shows in a dynamic way who gains from trade when the world price is above the domestic, no trade price. Hidden slide

28. Taxes, trade, & welfareslide 27 D Q Q $/Q Welfare changes due to exports of computers D Q $/Q S S No trade CS No trade PS World price ExportsGain in surplus New CS New PS

29. Taxes, trade, & welfareslide 28 Summary and conclusions Allowing trade in a good will always increase social welfare (the sum of producer and consumer surplus). When a good is exported, suppliers gain and consumers lose, compared to the no trade position. When a good is imported, suppliers lose and consumers gain, compared to the no trade position.