Application: The Costs of Taxation

key concept: Government imposes taxes to raise revenue. A tax places wedge between paid and received amount. Therefore, the quantity of goods in the market falls. Moreover, tax decreases consumer and producer surplus.
A TAX HAS DEADWEIGHT LOSS DUE TO INCENTIVES. THE CHANGES IN THE PEOPLE'S BEHAVIORS CAUSE THE MARKET TO SHRINK BELOW OPTIMUM.

key terms:
deadweight loss: a market distortion which causes the decrease in total surplus


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http://www.econmodel.com/classic/terms/deadweight_loss.htm//

The Deadweight Loss of Taxation:

Effects of Tax: A tax imposed on a market creates a wedge between the price paid by the buyers and the price received by the sellers. As a result, the quantity of goods sold in the market decreases. Tax causes either supply or demand curve to shift. It depends on to who the tax is directly imposed on, although both share the burden of the tax.
If the buyers are taxed, the demand curve shifts.
If the sellers are taxed, the supply curve shifts.
When tax is levied on a market, the government receives tax revenue, also known as TxQ. Tax revenue is used to enhance public services.

How a Tax Affects Welfare


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Deadweight loss: C+E
Taxes distort the incentives, which causes the allocation of resources to be inefficient.
Taxes create deadweight loss since the buyers and sellers fail to realize the gains from trade.
Taxes decrease surplus in the market.
GAINS FROM TRADE < TAX

Determinants of Deadweight Loss

Price elasticities of the supply and demand determine the size of dead weight loss.
*Greater elasticities of supply and demand, greater the deadweight loss.

More tax= more revenue and more deadweight loss//. Yet, deadweight loss rises faster than the size of the tax revenue. Deadweight loss continually increases as tax increases.yj.pnglafr.png



Tax revenue at first increases than decreases- shown in a Laffer Curve.

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Summary
Government imposes taxes to raise revenue. Tax decreases consumer and producer surplus. It causes DWL to occur. A tax imposed on a market creates a wedge between the price paid by the buyers and the price received by the sellers. As a result, the quantity of goods sold in the market decreases. Tax causes either supply or demand curve to shift. It depends on to who the tax is directly imposed on, although both share the burden of the tax. Tax revenue is used to enhance public services.

Questions:
1. What determines the size of the deadweight loss?
2. Is tax revenue is bigger than the deadweight loss?
3. Deadweight loss is cause by ___
4. Do surplus decreases when tax is levied?
5 How do you know, which curve (supply or demand) shifts?

Answers:
1. elasticities of supply and demand
2. No, deadweight loss is bigger
3. tax
4. Yes because tax distorts the incentives of people, which makes the market shrink.
5. It depends on who the tax is directly imposed on. If it is imposed on buyers, demand curve shifts. If it is imposed on sellers, supply curve shifts.




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