Principles of Economics- Mankiw (5th) 160

Principles of Economics- Mankiw (5th) 160 - 166 PA R T T H...

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166 PART THREE SUPPLY AND DEMAND II: MARKETS AND WELFARE deadweight loss: It is a loss to buyers and sellers in a market not offset by an increase in government revenue. From this example, we can see the ultimate source of deadweight losses: Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade. The area of the triangle between the supply and demand curves (area C + E in Figure 8-3) measures these losses. This loss can be seen most easily in Figure 8-4 by recalling that the demand curve reflects the value of the good to consumers and that the supply curve reflects the costs of producers. When the tax raises the price to buyers to P B and lowers the price to sellers to P S , the marginal buyers and sell- ers leave the market, so the quantity sold falls from Q 1 to Q 2 . Yet, as the figure shows, the value of the good to these buyers still exceeds the cost to these sellers. As in our example with Joe and Jane, the gains from trade—the difference between
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This note was uploaded on 07/30/2010 for the course ECON 120 taught by Professor Abijian during the Spring '10 term at Mesa CC.

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