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Tax Incidence & Elasticity Who actually bears the burden of taxes? Chapter 6 (pages 124-131) Tax Incidence • Tax incidence- is the study of who bears the burden of a tax • Regardless of who pays the tax directly to the Gov’t => buyers & sellers both bear some of the tax incidence (burden) – Buyers pay a higher price – Sellers Receive a lower price Tax Incidence & Elasticity • The degree of tax incidence (tax burden) depends on the relative elasticity of demand versus elasticity of supply • Bottom line: Tax incidence is greater on the more inelastic market The Steeper Curve pays more of the tax! Taxes & Shifting Supply/Demand • A tax on sellers shifts the supply curve left by amount of tax – End result is identical to drawing a “tax wedge” • A tax on buyers shifts the demand curve left by amount of tax – End result is identical to drawing a “tax wedge” If Gov’t taxes Sellers Seller pays Gov’t Shift supply left Buyer pays Gov’t If Gov’t taxes Buyers Shift demand left $.50 Cent Tax on Sellers Example #1 Price of Ice-Cream Price Cone buyers pay $3.30 3.00 Price 2.80 without tax S2 Equilibrium with tax S1 A tax on sellers shifts supply left by size of tax ($0.50) Tax ($0.50) Equilibrium without tax Price sellers receive D1 0 90 100 Quantity of Ice-Cream Cones Shifting Supply or Demand Curves • Tax incidence does not depend on who the tax is “placed on” – i.e. who “sends tax” to the Government • Shifting the demand or supply curve is an “illusion” – It only tells you who “paid” the Gov’t => not who “bears” the burden • The end result of the tax in terms of DWL, Tax Revenue, Tax Incidence is the same regardless of which curve you shift! $.50 Cent Tax on Buyers Price of Ice-Cream Price Cone buyers pay $3.30 Price 3.00 2.80 without tax Price sellers receive Supply, S1 Equilibrium without tax Tax ($0.50) A tax on buyers shifts demand curve left by the size of the tax New Equilibrium with tax Buyers pay $0.30 of tax Sellers pay $0.20 of tax Result is the same as When you taxed sellers! 0 90 100 D1 D2 Quantity of Ice-Cream Cones Tax Incidence Worksheet Price T-Shirts $20 S1 -------------- E1 ------------- $10 100 D1 Qty Inelastic Curves • Tax incidence is higher on curve that is more inelastic – Shifting a curve only tells you who “pays” tax • Deadweight Loss is smaller for inelastic curves • Tax revenue raised is higher S D Inelastic Curves lead to: 1) 2) 3) Higher tax incidence Lower DWL Higher Tax Revenue