KW_Macro_Ch_05_Sec_04_Applying_Consumer_and_Producer_Surplus_The_Efficiency_Costs_of_a_Tax

KW_Macro_Ch_05_Sec_04_Applying_Consumer_and_Producer_Surplus_The_Efficiency_Costs_of_a_Tax

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>> Consumer and Producer Surplus Section 4: Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax chapter 5 The concepts of consumer and producer surplus are extremely useful in many eco- nomic applications. Among the most important of these is assessing the efficiency cost of taxation. In Chapter 4 we introduced the concept of an excise tax , a tax on the purchase or sale of a good. We saw that such a tax drives a wedge between the price paid by con- sumers and that received by producers: the price paid by consumers rises, and the price received by producers falls, with the difference equal to the tax per unit. And as we saw in that chapter, the incidence of the tax—how much of the burden falls on consumers, how much on producers—does not depend on who actually writes the check to the gov- ernment. Instead, the burden of the tax depends on how responsive the quantity demanded is to changes in the price and how responsive the quantity supplied is to changes in the price.
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When the quantity of a good demanded is responsive to changes in that good’s price, economists call the demand for that good elastic. When the quantity of a good demanded is not very responsive to changes in that good’s price, they call the demand for that good inelastic. More precisely, we say that demand for a good is elas- tic if, for any given rise in the price of the good, the quantity demanded falls by a greater proportion than the price rises. For example, if the demand for a packet of potato chips falls by 25% when the price rises by 10%, we say that the demand for potato chips is elastic because 25% is greater than 10%. In other words, the demand for a good is elastic if the quantity demanded is relatively responsive to changes in the price. When demand is elastic, the demand curve will be relatively flat: even a small change in the price will result in a relatively large change in the quantity demanded. If the quantity of a good demanded falls by a smaller proportion than the price rises, demand for the good is said to be inelastic. For example, if the demand for gasoline falls by 5% when the price rises by 15%, we say that the demand for gasoline is inelastic because 5% is smaller than 15%. That is, the demand for a good is inelastic if the quantity demanded is relatively unresponsive to changes in price. When demand is inelastic, the demand curve will be relatively steep: even large changes in the price will result in only relatively small changes in the quantity demanded. We use a similar concept to describe the responsiveness of the quantity of a good supplied to changes in that good’s price. If the quantity of a good supplied rises by a greater proportion than the price rises, supply of the good is said to be elastic. When supply is elastic, the supply curve will be relatively flat: the quantity supplied is rela- tively responsive to changes in the price. But if the quantity of a good supplied rises by a smaller proportion than the price rises, supply of the good is said to be inelastic. When supply is inelastic, the supply curve will be relatively steep: large changes in the
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KW_Macro_Ch_05_Sec_04_Applying_Consumer_and_Producer_Surplus_The_Efficiency_Costs_of_a_Tax

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