PEco Module 6

• The effects of a tax can be summarized as follows: Sellers receive a payment, buyers pay a bill, and the size of the tax is represented as $T.
• An increase in the size of a tax causes revenue to rise at first, but eventually revenue falls because the tax reduces the size of the market.
• Deadweight loss is the fall in total surplus that results from a market distortion, such as a tax.
• The elasticity associated with deadweight loss value is determined by the price elasticities of supply and demand.
• Taxes affect the economic well-being of market participants by increasing the cost of goods and services.
• The effects of a tax can be measured using welfare economics, which determines consumer surplus, producer surplus, tax revenue, and total surplus with and without the tax.
• Tax revenue can fund beneficial services such as education, roads, and police, so it is included in total surplus.
• Without a tax, total surplus equals consumer surplus plus producer surplus, represented as A + B.
• With the tax, total surplus equals consumer surplus minus producer surplus, represented as A - B.
• The deadweight loss of a tax, represented as C + E, is the fall in total surplus that results from a market distortion, such as a tax.
• The size of the deadweight loss depends on the price elasticities of supply and demand.
• When supply is inelastic, the tax only reduces quantity a little, and the deadweight loss is small.
• When supply is elastic, the tax reduces quantity significantly, and the deadweight loss is large.
• When demand is inelastic, the tax only reduces quantity a little, and the deadweight loss is small.
• For the typical worker, the marginal tax rate is about 40%.
• The supply curve reflects sellers’ costs, producer surplus is the area between the supply curve and the price, D + E + F.
• Total surplus with the tax is area A + B + D + F.
• The larger the DWL from taxation, the greater the argument for smaller government.
• The price elasticities of demand and supply measure how much buyers and sellers respond to price changes.
• A tax on a good reduces the welfare of buyers and sellers.
• Some economists believe labor supply is inelastic, arguing that most workers work full-time regardless of the wage.
• If labor supply is inelastic, then the DWL from this tax is small.
• A bigger government provides more services, but requires higher taxes, which cause DWLs.
• Welfare without a tax is represented by the equilibrium price and quantity found at the intersection of the supply and demand curves.
• The tax on labor income is the biggest source of govt revenue.
• A tax has a DWL because it causes consumers to buy less and producers to sell less, thus shrinking the market below the level that maximizes total surplus.
• The fall in total surplus (consumer surplus, producer surplus, and tax revenue) is called the deadweight loss (DWL) of the tax.
• The price received by sellers falls from P1 to PS, so producer surplus now equals only area f.
• Higher elasticities imply higher DWLs.
• The more Q falls below the surplus-maximizing quantity, the greater the DWL.
• An increase in the size of a tax causes the DWL to rise even more.
• The more elastic is demand, the easier for buyers to leave the market when the tax increases.
• The demand curve reflects buyers’ willingness to pay, consumer surplus is the area between the demand curve and the price, A + B + C.
• Welfare with a tax is represented by the price paid by buyers rising from P1 to PB, so consumer surplus now equals only area a.