There will be no deadweight loss because the number of transactions remains constant.
You can see this equality by looking at the shaded areas in both panels.
The blue area of consumer surplus is equal to the red area of producer surplus in panel.
The green area in panel (b) is subtracted from the blue area in panel (a) in order to show that the surplus is redistributed from consumers to the government.
Even though some of the surplus is now in the form of a tax, society still enjoys the same total surplus.
The burden of taxation is paid by the consumer when demand is inelastic.
A tax on a good with almost perfectly inelastic demand is a transfer of welfare from consumers of the good to the government.
Milk is the subject of a tax on a product with more elastic demand.
The demand for milk is not price sensitive.
When the good was not taxed, the net price they charge is less than what they received.
The con sumers with a relatively low willingness to pay for the good are priced out of the market because of the tax increase.
sellers with high costs of production will stop producing the good because the price they net after paying the tax drops to P3.
Welfare will be transferred from consumers to the government if a tax on a good is elastic.
Deadweight loss is created because quantity bought and sold in the market declines.
Market Outcomes and Tax Incidence surplus and producer surplus in panel is greater than the sum of the consumer surplus, tax revenue, and producer surplus in panel because the deadweight loss in panel is no longer a part of the surplus.
The efficiency of the market is smaller because the total surplus is lower.
When demand is elastic we have seen the effect of taxation.
A customer who wants to buy fresh lettuce at a produce market will find many local growers charging the same price and many varieties to choose from.
Consumers will stop buying from a vendor if they are charged more than the market price.
When they can get the same product from another grower at a lower price, they will be willing to pay more.
Their demand is very elastic.
The result of a tax on lettuce is shown in Figure 5.11.
When lettuce is taxed, consumers can switch to other greens such as cabbage, or endive and avoid the tax.
Consumers are unwilling to accept price increases in this market.
It will cause deadweight loss.
They are worse off because less is produced and sold.
The result is deadweight loss.
The market's total sur plus is smaller than before.
The size of the tax revenue is noticeably smaller in the market.
There are two effects.
The supply curve shifts from S1 to S2 because producers are less willing to sell at all prices.
Consumers pay the same price because demand is elastic.
The tax increase causes the producers to lose money.
Producers offer less for sale after the tax is implemented because P3 is lower than P2.
There is deadweight loss because Q2 is smaller than Q1.
This is an important lesson for policymakers.
If the goal is to generate tax revenue or minimize efficiency losses, they should tax goods with relatively inelastic demand.
Doing so will reduce the deadweight loss of taxation and generate larger tax revenues for the government.
We have varied the elasticity of the demand curve and held the elasticity of the supply curve constant.
The equilibrium price would go up from E1 to E2 if we did the reverse and varied the elasticity of the supply curve.
There is a simple method for determining incidence and deadweight loss in this case.
The incidence of a tax is determined by the steepness of the demand curve.
Consumers bear more of the tax when the demand curve is more inelastic than the supply curve.
Suppliers bear more of the tax when the supply curve is more inelastic than the demand curve.
Deadweight loss is minimized when the supply and demand curves are steep.
Let's look at an example in which elasticity of demand and elasticity of supply interact.
A tax of $5 per pound is placed on shiitake mushrooms.
The incidence of the tax is the first thing we should discuss.
The market price goes up from $18 per pound to $20 per pound after the tax is in place.
Since sellers have to pay $5 per pound to the government, they keep only 15.
We need to compare the incidence of the tax paid by each party in order to measure the share of tax paid by buyers and sellers.
The demand curve is more elastic than the supply curve, so sellers have a limited ability to raise their price.
The deadweight loss caused by the tax is the decrease in economic activity.
There will be no mushroom sales because of the tax.
The number of units sold after the tax is 50 is known as the base.
The Budget Reconciliation Act of 1990 imposed a special tax on the sale of new aircraft, yachts, automobiles, furs, and jewelry.
The act imposed a 10% surcharge on new purchases of aircraft over $500,000, yachts over $100,000, automobiles over $25,000, and furs and jewelry over $10,000.
The taxes were expected to bring in $2 billion a year.
Thousands of jobs were lost in each of the affected industries as revenue fell far below expectations.
The tax was repealed in three years.
Basic demand elasticity was not considered when the Budget Reconciliation Act was passed.
Because the purchase of a new aircraft, yacht, car, fur, or jewelry is highly discretionary, many wealthy consumers decided that they would buy substitute products that fell below the tax threshold.
The demand for these goods was elastic.
When goods with elastic demand are taxed, the tax revenues are small.
In this example, the decrease in purchases was significant.
Congress repealed the tax in 1993 because of low revenues and job losses.
The populist idea of taxing the rich is not easy to implement.
It is nearly impossible to tax the toys the rich enjoy because wealthy people can spend their money in so many different ways.
They can avoid paying luxury taxes.
We have kept the size of the tax increase constant.
We were able to examine the impact of elasticity of demand and supply on deadweight loss and tax revenues.
In 2002 the Republic of Ireland instituted a tax of 15 euro cents on each plastic bag in order to curb litter and encourage recycling.
A 15- euro- cent tax is enormous since the cost of each plastic bag is just a few pennies.
The consumer use of plastic bags fell quickly.
The tax was a success because the government was able to curb litter.
In this section, we look at how consumers respond to taxes of different sizes, as well as the relationship between the size of a tax and deadweight loss.
The market response to tax increases is shown in Figure 5.13.
The price can be traced from panel a, where there is no tax and the price is P1, all the way to panel e, where the extreme tax causes the price to rise to P5.
The increase can be seen by comparing the sizes of the yellow triangles.
The trade- off is not going well.
Without taxes, deadweight loss doesn't happen.
The market equilibrium quantity demanded begins to decline when taxes are in place.
The area of deadweight loss expands as the number of transactions decreases.
The tax revenue is large relative to the deadweight loss when taxes are small.
The tax revenue is larger than the deadweight loss.
The deadweight loss is much larger than the tax revenue.
The panels show that prices go up when taxes are increased.
Higher taxes lead to more deadweight loss.
It's usually to raise revenue.
Taxes can influence citizens' behavior.
There are sometimes two reasons in play.
Some tax initiatives have been created by these two motives.
The tattoo tax in Maryland went from a fee of $2.50 to $5.00 a month in 2012 to a fee of $5.00 a month in the same year.
Revenue is generated for reducing pollution in the bay.
England passed a tax on cream cheese from delis and New Yorkers love their bagels.
Any bagel that has been more windows in one's house, sliced or spread higher the tax is what the state is targeting wealthy citizens.
bricked over their windows, many homeowners on it are subject like cream cheese.
The government did not tax them because they could not seal all of them.
The state of Alabama doesn't tax per pound on anyone growing.
The licensing fee is $2 a year.
The purchasing behavior of New Yorkers may be affected by the tax.
You and two friends are talking about taxation.
A friend of mine argues that tax rates are too high.
The other friend thinks tax rates are too low.
The answer is yes.
The amount of deadweight loss is more than the amount of tax revenue collected.
This result was observed in our discussion of the short- lived luxury tax.
Fiscal conservatives believe that taxes impede economic activity.
Progressives prefer higher tax rates than fiscal conservatives because a moderate tax rate creates more tax revenue than a small tax does.
More government services can be funded by the additional revenues generated by moderate tax rates.
Depending on how you view the value created by markets versus the value added through government provision, there is plenty of room for disagreement about the best tax policy.
Panel (e) shows an extreme case in which all market activity ceases as a result of the tax.
There is no tax revenue because nothing is produced or sold.
The misconception was that taxes on firms do not affect consumers.
This misconception is completely false.
Firms are able to transfer most of the tax incidence to consumers through higher prices because the government mostly taxes goods that have inelastic demand.
In the first part of the chapter, we learned that society benefits from unregulated markets.
Deadweight loss is a form of market failure caused by the taxation of specific goods and services.
A deep understanding of how society will respond to the incentives created by the legislation is required for any intervention in the market.