1Chapter 7Taxes>>THIRD EDITIONMICROECONOMICSPaul Krugman | Robin Wells
•The effects of taxes on supply and demand in a competitive market•What determines who really bears the burden of a tax•The costs and benefits of taxes, and why taxes impose a cost that is larger than the tax revenue they raise•The difference between progressive and regressive taxes and the trade-off between tax equity and tax efficiencyWHAT YOUWILL LEARNIN THIS CHAPTER
3The Economics of Taxes: A Preliminary View•An excise tax is a tax on sales of a good or service.§Examples: ØAn excise tax levied on sales of hotel accommodation (paid by the hotel guest). ØAn excise tax levied on sales of alcohol (paid by the retail shop). •Taxes drive a wedge between the price buyers pay and the price sellers receive.§Buyers will have to pay more.§Seller will receive less.•The tax incidenceis a measure of who bears the burden for a tax (who really pays for the tax).
4The Supply and Demand for Hotel RoomsSD05,00010,00015,000$14012010080604020EBPrice of hotel roomQuantity of hotel roomsEquilibrium quantityEquilibrium priceQSupply if price was $60QDemand if price was $100A
5An Excise Tax Imposed on Hotel OwnersS1S2AB05,00010,00015,000$14012010080604020Quantity of hotel roomsPriceDEExcise tax = $40 per roomSupply curve shifts upward by the amount of the tax.The equilibrium price of hotel rooms rises to $100 a night.And the quantity falls to 5,000Hotel guests bear some of the burden as price RISES from $80 to $100.Hotel owners also bear some of the burden as their price (net of the tax paid) FALLS from $80 to $60.The $40 excise tax is shared between buyers and sellers.
6An Excise Tax Imposed on Hotel GuestsAB05,00010,00015,000$14012010080604020Quantity of hotel roomsESD2D1Excise tax = $40 per roomDemand curve shifts downward by the amount of the tax.PriceThe equilibrium price of hotel rooms falls to $60 a night.And the quantity falls to 5,000.Hotel guests also bear some of the burden as price RISES from $80 to $100 (after taxes are paid).Hotel owners bear some of the burden as their price FALLS from $80 to $60.The incidence of an excise tax doesn’t depend on who officially pays the tax.
7Active Learning PracticeIf Ais the buyer price and Bthe seller price, how large is the per-unit tax imposed on the graph?a)$5b)$10c)$15d)$50e)$1,000AB0100200300$3530252015105ESD1PriceQuantity
8•The incidence of a tax is a measure of who really pays it.•Who really bears the tax burden (in the form of higher prices to consumers and lower prices to sellers) does not depend on who officially pays the tax. Depending on the shapes of supply and demand curves, the incidence of an excise tax may be divided differently.•The wedge between the demand price and supply price becomes the government’s tax revenueTax Incidence.
9An Excise Tax Paid Mainly By ConsumersDS$2.952.001.95Price of gasoline (per gallon)0Quantity of gasoline (gallons)Tax burden falls mainly on consumersExcise tax = $1 per gallonWhen the price elasticity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls mainly on consumers.