2. ©2001Claudia Garcia-Szekely1 The Effect of a Tax Levied on the Producer

3. ©2001,2002Claudia Garcia-Szekely2 The Effect of a $10 Tax Paid by Producers 60 500 If the price is $60 per unit, producer would produce 500 units After tax, producers receive only $50 At $50, producers would not bring 500 units for sale. 70 S0S0 For producers to be willing to produce 500 units, the consumer must pay $70 5050 Less than 500

4. ©2001,2002Claudia Garcia-Szekely3 The Effect of a $10 Tax Paid by Producers 10 S0S0 The same would be true for all quantities… 60 70 500 10 53 63 260 S plus tax The tax is equivalent to an increase in cost.

5. ©2001,2002Claudia Garcia-Szekely4 After Tax Equilibrium Price 60 500 70 S0S0 S1S1 After the shift in supply, the new equilibrium price is higher than $60 New Equilibrium Price New Equilibrium Quantity But is NOT $70!!

6. 5 After the tax… 60 500 S0S0 S with tax And pay a higher price: P c The government receives t (tax per unit) The producer receives P c - t P c - t Consumers purchase fewer units New Equilibrium Price PcPc New Equilibrium Quantity t t

7. ©2001,2002Claudia Garcia-Szekely6 A Producer Tax The tax drives a “wedge” between the price the buyer pays 60 500 P c - t PcPc Tax and the price the seller receives

8. ©2001,2002Claudia Garcia-Szekely7 P S Welfare Loss From a Tax D Q $ S P=$2 4 C S $1 PS CS Tax Revenue Welfare Loss 3 Tax = $2 per unit

9. 4 6 8 9 S0S0 2 3 5 7 10 4030205010607080 Impose a $2 tax on Producers 1. Shift Supply up by the amount of the tax

10. 4 6 8 9 S0S0 S tax 2 3 5 7 10 t=$2 403020501060 PCPC 2. Find the new equilibrium price: Pc the price the consumer pays after the tax

11. 4 6 8 9 S0S0 S tax 2 3 5 7 10 t=$2 403020501060 PC=PC= PP=PP= 3. Drop a line to the OLD supply curve: this represents subtracting the tax from the price the consumer pays, to get the price the producer receives

12. 4 6 8 9 S0S0 S tax 2 3 5 7 10 403020501060 PC=PC= PP=PP= 3. Ignore the Supply +tax line to determine CS, PS and Tax Revenue. CS PS Tax Revenue

13. 4 6 8 9 S0S0 2 3 5 7 10 403020501060 PC=PC= PP=PP= 4. At equilibrium (before the tax) 40 units are produced. CS PS Tax Revenue WL After the tax, only 30 units are produced: Tax creates a Welfare Loss

14. 4 6 8 9 S0S0 2 3 5 7 10 403020501060 PC=PC= PP=PP= CS =3*30*1/2 3*30*1/2 = PS Tax Rev =2*30 WL= 2*10*1/2

15. ©2001Claudia Garcia-Szekely14 The Effect of a Tax Levied on the Consumer

16. 15 10 S0S0 The same would be true for all quantities… P c =60 P p =50 500 10 45 55 600 D0D0 10 D Tax If the price is $60 consumers buy 500 units With a $10 tax, the actual Price consumers pay to be willing to buy 500 units is $10 lower than before The Effect of a $10 Tax Paid by Consumers

17. 4 6 8 9 S0S0 2 3 5 7 10 4030205010607080 Impose a $2 tax on Consumers 1. Shift Demand down by the amount of the tax

18. 4 6 8 9 S0S0 2 3 5 7 10 4030205010607080 2. Find the new equilibrium price: Pp Price the producer receives after the tax 3. Draw a line up to the OLD demand curve: this represents adding the tax from the price the producer receives, to get the price the consumer pays

19. 4 6 8 9 S0S0 S tax 2 3 5 7 10 403020501060 PC=PC= PP=PP= CS PS Tax Revenue Tax WL

20. 4 6 8 9 D0D0 D tax 2 3 5 7 10 403020501060 S0S0 $2 tax on Producer $2 tax on consumer PCPC P S tax

21. 4 6 8 9 D0D0 D tax 2 3 5 7 10 403020501060 S0S0 $2 tax on Producer $2 tax on consumer PCPC P $4 tax on consumer $4 tax on Producer PCPC P

22. 4 6 8 9 D0D0 D tax 2 3 5 7 10 403020501060 S0S0 $2 tax on Producer $2 tax on consumer PCPC P S tax

23. ©2001,2002Claudia Garcia-Szekely22 Regardless of Who Pays the Tax Pe Qe Tax Price Consumer Pays Price Producer Receives As price Increases quantity demanded falls As price drops quantity supplied falls The Consumer The Producer

24. ©2001,2002Claudia Garcia-Szekely23 Determining the Burden of The Tax Regardless on who the tax is levied on, consumers and producers end up “sharing” the burden of the tax… 60 500 P c -t PcPc Consumers now pay $t c more per unit. Producers now receive $t p less per unit sold tctc tptp

25. 24 The more Inelastic Demand is relative to Supply: Larger the price increase to consumer The smaller the price drop to producer P Q PpPp PcPc tctc tptp PcPc PcPc tctc tctc

26. ©2001,2002Claudia Garcia-Szekely25 60 500 57 67 490 If Demand is more inelastic than Supply The price the consumer pays after tax is $7 higher The price the producer receives after tax is $3 lower Clearly, the consumer bears a larger burden of the tax than the producer… Extra cost to consumer Cost to producer 7 x 490 3 x 490 10

27. 26 The more Inelastic Supply is relative to Demand: Smaller the price increase to consumer The larger the price drop to producer P Q P 0 -t P0P0 tctc tptp

28. ©2001,2002Claudia Garcia-Szekely27 The more Inelastic Supply is relative to Demand: A 70 unit decrease in quantity demanded, requires a “smaller” increase in price A 70 unit decrease in quantity supplied, requires a “larger” decrease in price 500430 60 S0S0 53 63

29. ©2001,2002Claudia Garcia-Szekely28 The more Inelastic Supply is relative to Demand: The price the consumer pays after tax is $3 higher The price the producer receives after tax is $7 lower Clearly, the producer bears a larger burden of the tax than the consumer… 500430 60 S0S0 53 63

30. 29 e p d = %  Q d /%  P 60 500 S0S0 65 450 At new equilibrium: quantity demanded and quantity supplied must both drop by the same amount: say 10% Since the elasticity of demand is equal to the elasticity of supply say: 1.2 e p s = %  Q s /%  P 8.3% increase 8.3% decrease 55 10% decrease -10% -1.2 When Demand and Supply have the Same Elasticity The % change in price must also be the same.

31. ©2001,2002Claudia Garcia-Szekely30 When Demand and Supply have the Same Elasticity The price the consumer pays after tax is $5 higher The price the producer receives after tax is $5 lower The tax burden is equally shared… 60 S0S0 65 55

32. ©2001Claudia Garcia-Szekely31 Regardless of Who Pays the Tax The Burden of the tax falls more heavily on the group with the lowest elasticity

33. TAX ON INSURANCE “If the government imposes a tax on insurance companies, the tax will be entirely passed on to consumers and insurance premiums will increase” Is this true? When is this true? We need to know first if demand for health insurance is more or less inelastic than supply If Demand is more inelastic is this true? 32 Would it help if the government offers more alternatives for consumers to purchase insurance?

34. ©2001,2002Claudia Garcia-Szekely33 If Demand is More Inelastic Than Supply… 60 500 S0S0 57 480 DD tax 67 The price the consumer pays after tax is $7 higher The price the producer receives after tax is $3 lower Clearly, the consumer bears a larger burden of the tax than the producer…

35. ©2001,2002Claudia Garcia-Szekely34 The More Elastic Demand Is Relative to Supply Pe Qe Price Consumer Pays D0D0 D1D1 D2D2 The smaller the increase in price necessary to reduce the quantity demanded The smaller the burden of the tax shared by the consumer

36. 35 Percentage of the tax burden on Producer Producer’s tax Share Price Elasticity of Demand Price elasticity of Supply + Price elasticity of Demand X100= e p d = 0.7 e p s = 0.1 0.7 0.1 + 0.7 = 0.8 87.5%

37. ©2001,2002Claudia Garcia-Szekely36 The More Elastic Demand is Relative to Supply Pe Qe D0D0 D1D1 D2D2 Price Producer Receives The larger the drop in price necessary to reduce the quantity supplied The larger the burden of the tax shared by the producer

38. ©2001,2002Claudia Garcia-Szekely37 Pe Qe Smaller the drop in quantity after the tax is imposed The smaller the welfare loss Same size tax Inelastic supply and demand Elastic Larger the drop in quantity after the tax is imposed The larger the welfare loss The larger the elasticity of demand and supply, the larger the welfare loss

39. ©2001,2002Claudia Garcia-Szekely38 Pe Qe The larger the tax revenue Inelastic supply and demand Elastic The larger the elasticity of demand and supply, the smaller the amount of tax revenue collected. Tax Revenue Same size tax Tax Revenue The smaller the tax revenue Larger the drop in quantity after the tax is imposed Smaller the drop in quantity after the tax is imposed

40. ©2001,2002Claudia Garcia-Szekely39 Percentage of the tax burden on Consumer Consumer’s tax Share Price Elasticity of Supply Price elasticity of Supply + Price elasticity of Demand X100= e p d = 0.7 e p s = 0.1 0.1 0.1 + 0.7 = 0.8 12.5%

41. ©2001,2002Claudia Garcia-Szekely40 Perfect Competition D Q $ MC Pe=$2 Qe=4000 C S P S

42. ©2001,2002Claudia Garcia-Szekely41 Government imposes a $6 tax on producer. Calculate: CS,PS,WL and tax revenue. Practice

43. ©2001,2002Claudia Garcia-Szekely42 CS PS WL S + tax $6 tax Tax Revenue 12-6 = Practice

44. ©2001,2002Claudia Garcia-Szekely43 Government imposes a $6 tax on consumer. Calculate: CS,PS,WL and tax revenue. Practice

45. ©2001,2002Claudia Garcia-Szekely44 Government imposes a $6 tax on consumer. Calculate: CS,PS,WL and tax revenue. CS PS Tax RevenueWL Practice

46. 45 Tax = db The effect of the tax is to (increase/decrease) price from ____to____ Practice

47. Price Consumer Pays =Price Producer Receives = Consumer Surplus =Producer Surplus = Tax Revenue = Welfare Loss = Tax = db Practice

48. 47 Price Consumer Pays = P 2 Price Producer Receives =P 2 -t Consumer Surplus =g c P 2 Producer Surplus =P 2 -t a e Tax Revenue =P 2 c a P 2 -t Welfare Loss =c b a CS WL Tax Revenue Tax = db PS Practice

49. Tax = db Lost Consumer Surplus = Lost producer surplus = Lost Consumer Surplus transferred to government= Lost Consumer Surplus not transferred but lost= Lost producer Surplus transferred to government = Lost producer Surplus not transferred but lost = z Practice

50. Tax = db Lost Consumer Surplus = Lost producer surplus = Lost Consumer Surplus transferred to government= Lost Consumer Surplus not transferred but lost= Lost producer Surplus transferred to government = Lost producer Surplus not transferred but lost = z CS Tax Revenue PS WL Lost PS Lost CS Lost CS to Government Lost PS to Government Lost CS NOT transferred but lost as WL Lost PS NOT transferred but lost as WL Practice

51. ©2001,2002Claudia Garcia-Szekely50 Government imposes a Price Ceiling at $6 Calculate: CS,PS and WL. Practice

52. ©2001,2002Claudia Garcia-Szekely51 Government imposes a Price Ceiling at $6 Calculate: CS,PS and WL. CS PS WL Practice

53. ©2001,2002Claudia Garcia-Szekely52 Government imposes a Price Ceiling at $6 Calculate: CS,PS and WL. CS PS WL (20 -12)*16*(1/2) (12-6)*16 (6-2)*16*(1/2) (12-6)*(24-16)*(1/2) Practice

54. ©2001,2002Claudia Garcia-Szekely53 Government imposes a Price Floor at $12 Calculate: CS,PS and WL. Practice

55. ©2001,2002Claudia Garcia-Szekely54 Government imposes a Price Floor at $12 Calculate: CS,PS and WL. CS PS WL Practice

56. ©2001,2002Claudia Garcia-Szekely55 Government imposes a Price Floor at $12 Calculate: CS,PS and WL. Triangle = (6- 2)*16*(1/2) Box =(12-6)*16 CS= (20-12)*16*(1/2) WL=(12-6)*(24-16)*(1/2) PS