Copyright©2004 South-Western
8Application: The
Costs of Taxation
Copyright © 2004 South-Western/Thomson Learning
Application: The Costs of Taxation
• Welfare economics is the study of how...
Copyright © 2004 South-Western/Thomson Learning
THE DEADWEIGHT LOSS OF
TAXATION
• How do taxes affect the economic well-be...
Copyright © 2004 South-Western/Thomson Learning
THE DEADWEIGHT LOSS OF
TAXATION
• It does not matter whether a tax on a go...
Figure 1 The Effects of a Tax
Copyright © 2004 South-Western
Size of tax
Quantity0
Price
Price buyers
pay
Price sellers
re...
Copyright © 2004 South-Western/Thomson Learning
How a Tax Affects Market Participants
• A tax places a wedge between the p...
Copyright © 2004 South-Western/Thomson Learning
How a Tax Affects Market Participants
• Tax Revenue
• T = the size of the ...
Figure 2 Tax Revenue
Copyright © 2004 South-Western
Tax
revenue
(T × Q)
Size of tax (T)
Quantity
sold (Q)
Quantity0
Price
...
Figure 3 How a Tax Effects Welfare
Copyright © 2004 South-Western
A
F
B
D
C
E
Quantity0
Price
Demand
Supply
= PB
Q2
= PS
P...
Copyright © 2004 South-Western/Thomson Learning
How a Tax Affects Market Participants
• Changes in Welfare
• A deadweight ...
Copyright © 2004 South-Western/Thomson Learning
How a Tax Affects Welfare
Copyright © 2004 South-Western/Thomson Learning
How a Tax Affects Market Participants
• The change in total welfare includ...
Copyright © 2004 South-Western/Thomson Learning
Deadweight Losses and the Gains from
Trade
• Taxes cause deadweight losses...
Figure 4 The Deadweight Loss
Copyright © 2004 South-Western
Cost to
sellersValue to
buyers
Size of tax
Quantity0
Price
Dem...
Copyright © 2004 South-Western/Thomson Learning
DETERMINANTS OF THE
DEADWEIGHT LOSS
• What determines whether the deadweig...
Figure 5 Tax Distortions and Elasticities
Copyright © 2004 South-Western
(a) Inelastic Supply
Price
0 Quantity
Demand
Supp...
Figure 5 Tax Distortions and Elasticities
Copyright © 2004 South-Western
(b) Elastic Supply
Price
0 Quantity
Demand
Supply...
Figure 5 Tax Distortions and Elasticities
Copyright © 2004 South-Western
Demand
Supply
(c) Inelastic Demand
Price
0 Quanti...
Figure 5 Tax Distortions and Elasticities
Copyright © 2004 South-Western
(d) Elastic Demand
Price
0 Quantity
Size
of
tax D...
Copyright © 2004 South-Western/Thomson Learning
DETERMINANTS OF THE
DEADWEIGHT LOSS
• The greater the elasticities of dema...
Copyright © 2004 South-Western/Thomson Learning
DEADWEIGHT LOSS AND TAX
REVENUE AS TAXES VARY
• The Deadweight Loss Debate...
Copyright © 2004 South-Western/Thomson Learning
DEADWEIGHT LOSS AND TAX
REVENUE AS TAXES VARY
• With each increase in the ...
Figure 6 Deadweight Loss and Tax Revenue from Three
Taxes of Different Sizes
Copyright © 2004 South-Western
Tax revenue
De...
Figure 6 Deadweight Loss and Tax Revenue from Three
Taxes of Different Sizes
Copyright © 2004 South-Western
Tax revenue
Qu...
Figure 6 Deadweight Loss and Tax Revenue from Three
Taxes of Different Sizes
Copyright © 2004 South-Western
Taxrevenue
Dem...
Copyright © 2004 South-Western/Thomson Learning
DEADWEIGHT LOSS AND TAX
REVENUE AS TAXES VARY
• For the small tax, tax rev...
Figure 7 How Deadweight Loss and Tax Revenue Vary
with the Size of a Tax
Copyright © 2004 South-Western
(a) Deadweight Los...
Figure 7 How Deadweight Loss and Tax Revenue Vary
with the Size of a Tax
Copyright © 2004 South-Western
(b) Revenue (the L...
Copyright © 2004 South-Western/Thomson Learning
DEADWEIGHT LOSS AND TAX
REVENUE AS TAXES VARY
• As the size of a tax incre...
Copyright © 2004 South-Western/Thomson Learning
CASE STUDY: The Laffer Curve and Supply-
side Economics
• The Laffer curve...
Copyright © 2004 South-Western/Thomson Learning
Summary
• A tax on a good reduces the welfare of buyers
and sellers of the...
Copyright © 2004 South-Western/Thomson Learning
Summary
• Taxes have a deadweight loss because they
cause buyers to consum...
Copyright © 2004 South-Western/Thomson Learning
Summary
• As a tax grows larger, it distorts incentives
more, and its dead...
Upcoming SlideShare
Loading in …5
×

Dead weight loss slide of KU

1,134 views

Published on

this slide contains the information about deadweight loss of KUSOM

Published in: Education, Technology, Business
2 Comments
0 Likes
Statistics
Notes
  • this is very helpful for us.
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • thank u bro..
       Reply 
    Are you sure you want to  Yes  No
    Your message goes here
  • Be the first to like this

No Downloads
Views
Total views
1,134
On SlideShare
0
From Embeds
0
Number of Embeds
3
Actions
Shares
0
Downloads
32
Comments
2
Likes
0
Embeds 0
No embeds

No notes for slide

Dead weight loss slide of KU

  1. 1. Copyright©2004 South-Western 8Application: The Costs of Taxation
  2. 2. Copyright © 2004 South-Western/Thomson Learning Application: The Costs of Taxation • Welfare economics is the study of how the allocation of resources affects economic well- being. • Buyers and sellers receive benefits from taking part in the market. • The equilibrium in a market maximizes the total welfare of buyers and sellers.
  3. 3. Copyright © 2004 South-Western/Thomson Learning THE DEADWEIGHT LOSS OF TAXATION • How do taxes affect the economic well-being of market participants?
  4. 4. Copyright © 2004 South-Western/Thomson Learning THE DEADWEIGHT LOSS OF TAXATION • It does not matter whether a tax on a good is levied on buyers or sellers of the good . . . the price paid by buyers rises, and the price received by sellers falls.
  5. 5. Figure 1 The Effects of a Tax Copyright © 2004 South-Western Size of tax Quantity0 Price Price buyers pay Price sellers receive Demand Supply Price without tax Quantity without tax Quantity with tax
  6. 6. Copyright © 2004 South-Western/Thomson Learning How a Tax Affects Market Participants • A tax places a wedge between the price buyers pay and the price sellers receive. • Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax. • The size of the market for that good shrinks.
  7. 7. Copyright © 2004 South-Western/Thomson Learning How a Tax Affects Market Participants • Tax Revenue • T = the size of the tax • Q = the quantity of the good sold T  Q = the government’s tax revenue
  8. 8. Figure 2 Tax Revenue Copyright © 2004 South-Western Tax revenue (T × Q) Size of tax (T) Quantity sold (Q) Quantity0 Price Demand Supply Quantity without tax Quantity with tax Price buyers pay Price sellers receive
  9. 9. Figure 3 How a Tax Effects Welfare Copyright © 2004 South-Western A F B D C E Quantity0 Price Demand Supply = PB Q2 = PS Price buyers pay Price sellers receive = P1 Q1 Price without tax
  10. 10. Copyright © 2004 South-Western/Thomson Learning How a Tax Affects Market Participants • Changes in Welfare • A deadweight loss is the fall in total surplus that results from a market distortion, such as a tax.
  11. 11. Copyright © 2004 South-Western/Thomson Learning How a Tax Affects Welfare
  12. 12. Copyright © 2004 South-Western/Thomson Learning How a Tax Affects Market Participants • The change in total welfare includes: • The change in consumer surplus, • The change in producer surplus, and • The change in tax revenue. • The losses to buyers and sellers exceed the revenue raised by the government. • This fall in total surplus is called the deadweight loss.
  13. 13. Copyright © 2004 South-Western/Thomson Learning Deadweight Losses and the Gains from Trade • Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade.
  14. 14. Figure 4 The Deadweight Loss Copyright © 2004 South-Western Cost to sellersValue to buyers Size of tax Quantity0 Price Demand SupplyLost gains from trade Reduction in quantity due to the tax Price without tax Q1 PB Q2 PS
  15. 15. Copyright © 2004 South-Western/Thomson Learning DETERMINANTS OF THE DEADWEIGHT LOSS • What determines whether the deadweight loss from a tax is large or small? • The magnitude of the deadweight loss depends on how much the quantity supplied and quantity demanded respond to changes in the price. • That, in turn, depends on the price elasticities of supply and demand.
  16. 16. Figure 5 Tax Distortions and Elasticities Copyright © 2004 South-Western (a) Inelastic Supply Price 0 Quantity Demand Supply Size of tax When supply is relatively inelastic, the deadweight loss of a tax is small.
  17. 17. Figure 5 Tax Distortions and Elasticities Copyright © 2004 South-Western (b) Elastic Supply Price 0 Quantity Demand SupplySize of tax When supply is relatively elastic, the deadweight loss of a tax is large.
  18. 18. Figure 5 Tax Distortions and Elasticities Copyright © 2004 South-Western Demand Supply (c) Inelastic Demand Price 0 Quantity Size of tax When demand is relatively inelastic, the deadweight loss of a tax is small.
  19. 19. Figure 5 Tax Distortions and Elasticities Copyright © 2004 South-Western (d) Elastic Demand Price 0 Quantity Size of tax Demand Supply When demand is relatively elastic, the deadweight loss of a tax is large.
  20. 20. Copyright © 2004 South-Western/Thomson Learning DETERMINANTS OF THE DEADWEIGHT LOSS • The greater the elasticities of demand and supply: • the larger will be the decline in equilibrium quantity and, • the greater the deadweight loss of a tax.
  21. 21. Copyright © 2004 South-Western/Thomson Learning DEADWEIGHT LOSS AND TAX REVENUE AS TAXES VARY • The Deadweight Loss Debate • Some economists argue that labor taxes are highly distorting and believe that labor supply is more elastic. • Some examples of workers who may respond more to incentives: • Workers who can adjust the number of hours they work • Families with second earners • Elderly who can choose when to retire • Workers in the underground economy (i.e., those engaging in illegal activity)
  22. 22. Copyright © 2004 South-Western/Thomson Learning DEADWEIGHT LOSS AND TAX REVENUE AS TAXES VARY • With each increase in the tax rate, the deadweight loss of the tax rises even more rapidly than the size of the tax.
  23. 23. Figure 6 Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Demand Supply Quantity0 Price Q1 (a) Small Tax Deadweight loss PB Q2 PS
  24. 24. Figure 6 Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Quantity0 Price (b) Medium Tax PB Q2 PS Supply Demand Q1 Deadweight loss
  25. 25. Figure 6 Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Taxrevenue Demand Supply Quantity0 Price Q1 (c) Large Tax PB Q2 PS Deadweight loss
  26. 26. Copyright © 2004 South-Western/Thomson Learning DEADWEIGHT LOSS AND TAX REVENUE AS TAXES VARY • For the small tax, tax revenue is small. • As the size of the tax rises, tax revenue grows. • But as the size of the tax continues to rise, tax revenue falls because the higher tax reduces the size of the market.
  27. 27. Figure 7 How Deadweight Loss and Tax Revenue Vary with the Size of a Tax Copyright © 2004 South-Western (a) Deadweight Loss Deadweight Loss 0 Tax Size
  28. 28. Figure 7 How Deadweight Loss and Tax Revenue Vary with the Size of a Tax Copyright © 2004 South-Western (b) Revenue (the Laffer curve) Tax Revenue 0 Tax Size
  29. 29. Copyright © 2004 South-Western/Thomson Learning DEADWEIGHT LOSS AND TAX REVENUE AS TAXES VARY • As the size of a tax increases, its deadweight loss quickly gets larger. • By contrast, tax revenue first rises with the size of a tax, but then, as the tax gets larger, the market shrinks so much that tax revenue starts to fall.
  30. 30. Copyright © 2004 South-Western/Thomson Learning CASE STUDY: The Laffer Curve and Supply- side Economics • The Laffer curve depicts the relationship between tax rates and tax revenue. • Supply-side economics refers to the views of Reagan and Laffer who proposed that a tax cut would induce more people to work and thereby have the potential to increase tax revenues.
  31. 31. Copyright © 2004 South-Western/Thomson Learning Summary • 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 revenues 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.
  32. 32. Copyright © 2004 South-Western/Thomson Learning Summary • Taxes have a deadweight loss because they cause buyers to consume less and sellers to produce less. • This change in behavior shrinks the size of the market below the level that maximizes total surplus.
  33. 33. Copyright © 2004 South-Western/Thomson Learning Summary • As a tax grows larger, it distorts incentives more, and its deadweight loss grows larger. • Tax revenue first rises with the size of a tax. • Eventually, however, a larger tax reduces tax revenue because it reduces the size of the market.

×