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Supply, Demand and Government Policies
Chapter 6
Copyright © 2001 by Harcourt, Inc.
All rights reserved. Requests for permission to make copies of any part of thework should be mailed to:
Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.
Taxes
Governments levy taxes to raise revenue for public
projects.
What are some potential impacts of taxes?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden.
Taxes
Tax incidence is the study of who bears the burden of a tax.
Taxes result in a change in market equilibrium.
Buyers pay more and sellers receive less, regardless of whom the tax is levied on.
Impact of a 50¢ Tax Levied on Buyers...
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
100
D1
Supply, S1
A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).
D2
Copyright © 2001 by Harcourt, Inc. All rights reserved
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
10090
$3.30
Pricebuyerspay
D1
D2
Equilibriumwith tax
Supply, S1
Equilibrium without tax
Impact of a 50¢ Tax Levied on Buyers...
2.80
Pricesellersreceive
Copyright © 2001 by Harcourt, Inc. All rights reserved
Pricewithouttax
Tax ($0.50)
What was the impact of tax?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden.
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
10090
S1
S2
Demand, D1
Impact of a 50¢ Tax on Sellers...
Price without tax
2.80
Price sellers receive
$3.30
Price buyers pay
Equilibrium without tax
Copyright © 2001 by Harcourt, Inc. All rights reserved
A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50).
Tax ($0.50)
Equilibriumwith tax
Impact of TaxesTax Wedges
Taxes on buyers and taxes on sellers are equivalent.
Taxes place a wedge between what the sellers receive and what the buyer pays.
The wedge shifts the relative position of the supply and demand curve so that buyers and sellers share the burden of the tax.
The Incidence of Tax
In what proportions is the burden of the tax divided?
How do the effects of taxes on sellers compare to those levied on buyers?
The answers to these questions depend on the elasticity of demand and the elasticity of supply.
Elastic Supply, Inelastic Demand...
Quantity0
Price
Demand
Supply
Tax
1. When supply is moreelastic than demand...
2. ...theincidence of thetax falls moreheavily onconsumers...
3. ...than onproducers.
Price without tax
Price buyers pay
Price sellers receive
Inelastic Supply, Elastic Demand...
Quantity0
Price
Demand
Supply
Price without tax
Tax
1. When demand is moreelastic than supply...
2. ...theincidence of the tax falls more heavily on producers...
3. ...than on consumers.
Price buyers pay
Price sellers receive
So, how is the burden of the tax divided?
The burden of a tax falls more heavily on the side of the market that is less
elastic.