Slide 1Knowledge RecapTaxesTaxesTaxesTaxesElasticity and Tax IncidenceElasticity and Tax IncidenceECON 203: Principles of MicroeconomicsClass 8: Taxes1Knowledge Recap•The economic framework provides tools that can be used to evaluate government policies.•Economic analysis can reveal unintended consequences of well-intentioned policies.–Example: a price floor in the form of a minimum wage meant to improve well-being of low-wage workers may lead to unemployment and a decrease in work hours.2Taxes•Government can impose taxes for two reasons.–Policy reasons: e.g. tax on gasoline or cigarettes.–To raise revenue for public projects.•A common policy question is whether the tax should be imposed on the buyer or seller.•Economic analysis shows that buyer and seller share the burden of the tax regardless of who “pays” it.3Taxes•Scenario 1: $0.50 tax on gas imposed on the sellers.–Immediate impact on the quantity sellers are willing to produce and sell for any given price.–Supply curve shifts to the left.•For any market price the price to the seller is $0.50 lower.–Decrease in the equilibrium quantity.–Increase in the equilibrium price paid by buyers.–Decrease in the per unit dollar amount received by sellers (effective price to sellers).4Taxes•Scenario 2: $0.50 tax on gas imposed on the buyers.–Immediate impact on the demand as perceived by the seller: for every $3.00 buyer pays, seller receives $2.50.–Demand curve (as perceived by seller) shifts to the left.•For every $3.00 buyer pays, seller receives $2.50.–Decrease in the equilibrium quantity.–Decrease in the equilibrium price received by sellers. –Increase in the per unit dollar amount paid by buyers (effective price to buyers).5Taxes•Implications of taxes.–Decrease in equilibrium quantity.–Increase in price for the buyers.–Decrease in price for the sellers.•Tax incidence describes how the tax burden is shared among buyers and sellers.Tax burden on buyers = price for buyers – price with no taxTax burden on sellers = price with no tax – price for sellers6Wedge between buyers’ price and sellers’ price.Elasticity and Tax Incidence•Tax incidence depends on the elasticity of demand and supply.–When supply is elastic and demand is inelastic the buyers bear a larger share of the burden.–When supply is inelastic and demand is elastic the sellers bear a larger share of the burden.–In general the tax burden falls more heavily on the side that is more inelastic.•Inelastic demand implies buyers are less willing to leave market.•Inelastic supply implies sellers are less willing to leave market.•The side that is less willing to leave the market bears more of the tax burden.7Elasticity and Tax Incidence•Example: taxes in markets with different elasticities.–Market 1: demand is inelastic and supply is elastic.–Market 2: demand is elastic and supply is inelastic.–Tax of $0.50 imposed in both markets driving an equivalent wedge between price for buyers and price for sellers.•In market 1 with inelastic demand buyers pay most of the tax.•In market 2 with inelastic supply sellers pay most of the
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