ch08 - Chapter8 Application:TheCostsofTaxation 8...

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Application: The Costs of Taxation WHAT’S NEW IN THE THIRD EDITION: There have been no substantial changes to this chapter. LEARNING OBJECTIVES: By the end of this chapter, students should understand: how taxes reduce consumer and producer surplus. the meaning and causes of the deadweight loss from a tax. why some taxes have larger deadweight losses than others. how tax revenue and deadweight loss vary with the size of a tax. CONTEXT AND PURPOSE: Chapter 8 is the second chapter in a three-chapter sequence dealing with welfare economics. In the  previous section on supply and demand, Chapter 6 introduced taxes and demonstrated how a tax affects  the price and quantity sold in a market. Chapter 6 also described the factors that determine how the  burden of the tax is divided between the buyers and sellers in a market. Chapter 7 developed welfare  economics—the study of how the allocation of resources affects economic well-being. Chapter 8  combines the lessons learned in Chapters 6 and 7 and addresses the effects of taxation on welfare.  Chapter 9 will address the effects of trade restrictions on welfare. The purpose of Chapter 8 is to apply the lessons learned about welfare economics in Chapter 7  to the issue of taxation that was addressed in Chapter 6. Students will learn that the cost of a tax to  155 8 APPLICATION:  THE COSTS OF  TAXATION
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156   Chapter 8 /Application: The Costs of Taxation buyers and sellers in a market exceeds the revenue collected by the government. Students will also learn  about the factors that determine the degree by which the cost of a tax exceeds the revenue collected by  the government.
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Chapter 8 /Application: The Costs of Taxation   157 KEY POINTS: 1. A tax on a good reduces the welfare of buyers and sellers of the good, and the reduction in consumer  and producer surplus usually exceeds the revenue raised by the government.  The fall in total surplus —the sum of consumer surplus, producer surplus, and tax revenue—is called the deadweight loss of  the tax. 2. Taxes have deadweight losses because they cause buyers to consume less and sellers to produce  less, and this change in behavior shrinks the size of the market below the level that maximizes total  surplus.  Because the elasticities of supply and demand measure how much market participants  respond to market conditions, larger elasticities imply larger deadweight losses.
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