1. IB Economics HL Topics Indirect Taxes, Subsidies and Price Controls

2. Tax Incidence (burden) ► Is a measure of the consequences of a tax on all the affected parties ► Tax impacts the profitability of any product, the degree may vary ► Whoever pays the tax suffers the tax burden

3. Tax incidence: PED similar to PES Price Quantity D S P1 Qe S + tax Ptax Tax Revenue Tax burden of consumer Qtax Pe Tax burden of producer

4. PED similar to PES ► Consumers and producers share the burden of tax equally ► Consumers pay more and receive less output ► Consumer and producer surplus decreased ► Market size was reduced from Qe to Qtax

5. Tax incidence: PED > PES Price Quantity D S P1 Qe S + tax Ptax Tax Revenue Tax burden of consumer Qtax Pe Tax burden of producer

6. PED > PES ► Demand is more elastic than supply ► Consumers are more responsive to price, and therefore less tolerant of price increases ► Producers pay more of the burden of the tax ► Government receives less revenue ► Market size decreases quite significantly, therefore employment is more likely to decline ► Deadweight loss is greater due to large decrease in quantity

7. Tax incidence: PED < PES Price Quantity D S P1 Qe S + tax Ptax Tax Revenue Tax burden of consumer Qtax Pe producer

8. PED < PES ► Consumers are relatively indifferent to price changes ► Consumers tax burden is greater than producers ► Government receives more revenue ► Market size decreases relatively little, therefore employment is less affected ► Deadweight loss is smaller

9. PED vs PES Summary ► The more elastic the demand relative to supply, the greater the burden paid by producers, the greater the deadweight loss, and the smaller the government revenue ► The more inelastic the demand relative to supply, the greater the burden paid by consumers, the smaller the deadweight loss, and the greater the government revenue

10. ► Government will place indirect taxes on products that have relatively inelastic demand  The demand will change in smaller proportion, gain high revenue and yet not cause a large fall in employment

11. Size of Deadweight Loss ► The deadweight loss of the tax will depend upon two factors:  The size of the tax  The reduction in the quantity sold ► The reduction in the quantity sold will depend upon the elasticity of demand and supply  The more elastic demand or supply is the larger the deadweight loss will be  If either demand or supply is price inelastic then the deadweight loss will be small and could be zero if perfectly inelastic (no change in the quantity sold and consumed)

12. Total Welfare before Tax A F B D C E QTY 0 Price D = MB S = MC = PBPB Q2Q2 = PSPS Price buyers pay Price sellers receive = P1P1 Q1Q1 Price without tax A + B + C = Consumer Surplus (before tax) Producer Surplus = D + E + F (before tax) E1E1 E 1 maximizes Total Welfare

13. Tax Affect on Total Welfare A F B D C E Quantity 0 Price D = MB S = MC = PBPB Q2Q2 = PSPS Price buyers pay Price sellers receive = P1P1 Q1Q1 Price without tax Area C + E is a complete loss to Society: (DEADWEIGHT LOSS) B + D = Tax Revenue

14. Tax incidence and Linear Function HL Page 107 Exercise

15. Additional graphs

16. Consumer Surplus Price Quantity D PoPo QoQo Maximum Willingness to Pay for Q o What is paid Consumer Surplus

17. Original Consumer Surplus Change in Consumer Surplus: Price Increase Quantity New Consumer Surplus Loss in Surplus: Consumers paying more Loss in Surplus: Consumers buying less Price D PoPo QoQo P1P1 Q1Q1

18. Minimum Amount Needed to Supply Q o Producer Surplus Price Quantity PoPo QoQo What is paid Producer Surplus S

19. Consumer and Producer Surplus Price Quantity PoPo QoQo S Producer Surplus Consumer Surplus D

20. Loss in Efficiency Too High of Price (Price Floor) Price Quantity PoPo QoQo S D QLQL New Consumer Surplus PHPH New Producer Surplus Lost Consumer Surplus Lost Producer Surplus Deadweight Loss

21. New Producer Surplus New Consumer Surplus Loss in Efficiency Too Low of Price (Price Ceiling) Price Quantity PoPo QoQo S D QLQL PLPL Lost Consumer Surplus Lost Producer Surplus Deadweight Loss

22. New Producer Surplus Tax Revenues New Consumer Surplus Loss in Efficiency Taxation Price Quantity PoPo QoQo S D QLQL PSPS Lost Producer Surplus PDPD S Tax Lost Consumer Surplus Deadweight Loss Tax

23. SubsidySubsidy

24. Loss in Efficiency Subsidy PoPo QoQo S D QHQH PDPD Subsidy Cost PSPS S Sub Subsidy New Producer Surplus Gain in Producer Surplus New Consumer Surplus Gain in Consumer Surplus Price Quantity Deadweight Loss