Price Ceilings, Price Floors, and Excise TaxesPowerPoint PresentationA binding price ceilingSlide 4Slide 5Slide 6AN IMPORTANT TAX PROBLEMSlide 8The tax raises the supply curve by the amount of the tax per unitSlide 10But price will rise by less than the amount of the tax, as the following diagram shows.The state’s tax revenue is $1 times the number of units sold.Tax BurdenWho pays the tax on cigarettes?Slide 17Slide 18Elasticity also determines the state's tax revenue.Slide 20Governments & markets slide 1Price Ceilings, Price Floors, and Excise TaxesGovernments & markets slide 2Price ceiling:A price above which it is illegal to charge.Binding price ceiling:A price ceiling set below the equilibrium price.Governments & markets slide 3A binding price ceilingSDqpp(max)Price can't rise above this level, so there's always excess demand.Governments & markets slide 4A binding price floorSDqpp(min)Price can't fall below this level so there's always a surplus.Governments & markets slide 5Binding price ceilings lead to shortages (excess demand).Binding price floors lead to surpluses (excess supply).Governments & markets slide 6Additional examples:Rent controlMinimum wage lawsMinimum agricultural pricesGovernments & markets slide 7AN IMPORTANT TAX PROBLEMSuppose the market for cigarettes is in equilibrium.Suppose the State of Michigan, in its wisdom, decides to impose a tax of $1 per pack on the sale of cigarettes.How does the tax affect the market for cigarettes?Governments & markets slide 8This kind of tax can be analyzed as if it were an input price increase. The tax is similar to having to pay a higher price for some input (government services?).The tax will raise the supply curve by the amount of the tax per unit.Governments & markets slide 9The tax raises the supply curve by the amount of the tax per unitpEQESDQpriceS + taxCIGARETTE MARKETThis distance is exactly $1.Governments & markets slide 10The reason the supply curve shifts up by exactly the amount of the tax is that price would have to rise by the full amount of the tax to induce cigarette suppliers to supply the amount they supplied before the tax.Governments & markets slide 11But price will rise by less than the amount of the tax, as the following diagram shows.Go to hidden slideGovernments & markets slide 13The state’s tax revenue is $1 times the number of units sold.pE’QESDQPS + taxQE’CIGARETTE MARKETtotal tax collectionsGovernments & markets slide 14Tax BurdenThe tax burden on consumers is the part of the tax paid by consumers in terms of higher prices.The tax burden on sellers is the part of the tax paid by firms in terms of lower receipts.Governments & markets slide 15Who pays the tax on cigarettes?S+TaxDSPQTax per unitGo to hidden slideGovernments & markets slide 17Tax burden on each is determined by the elasticities of supply and demand.Governments & markets slide 18Given the demand curve, more elastic (flatter) supply means greater tax burden for consumers.Given the supply curve, more elastic (flatter) demand means greater tax burden for sellers.[Hint: Don't try to memorize these statements. Instead, make sure you can figure out each case.]Governments & markets slide 19Elasticity also determines the state's tax revenue.For example:1) The more inelastic is the demand curve, the greater will be the state’s tax revenue.2) The more inelastic is the supply curve, the greater will be the state’s tax revenue.Governments & markets slide 20The next (hidden) slide shows these principles for different elasticities of demand.When demand is more elastic:Price rises less.There's relatively more burden on sellers.The state takes in less revenue.Go to hidden
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