Weeks3&4_Taxation

Weeks3&4_Taxation - TAX POLICY AND ECONOMIC...

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TAX POLICY AND ECONOMIC EFFICIENCY
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TAXATION Governments use taxation as their primary tool of raising revenue [for public projects and such]. While the necessity and the merit of the practice cannot be argued against, it should also be noted that taxation is costly. It leads to deadweight losses and discourages economic activity. Heavily-taxed markets are generally the ones with the lowest volume/number of transactions. Taxes can be imposed on both buyers and sellers. No matter how tax policy is designed, market quantity always falls. The price paid by the buyers always goes up and the net price received by the sellers always goes down.
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MECHANICS OF TAXATION The introduction of a tax is an external shock to the market and, as such, functions as a negative demand/supply shifter. ( A tax on sellers shifts the supply curve to left, for example.) The curves ( supply or demand depending on the type of the tax being introduced) shift by the exact size of the tax. (The vertical distance between the old and new curves is equal to the size of the tax.) Buyers and sellers share the burden of taxes. Buyers always pay more and sellers always receive less. The manner in which this burden is shared among market participants is explained by the concept of market incidence .
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CASE STUDY: A TAX ON SELLERS 2.80 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium with tax Equilibrium without tax Tax ($0.50) Price
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