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Exam 2- Economics - Taxes

by: Elina Doolabh

Exam 2- Economics - Taxes Economics 150

Marketplace > Wake Forest University > Economcs > Economics 150 > Exam 2 Economics Taxes
Elina Doolabh

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These notes go into detail about taxes
Introduction to Economics
Dr. Veronica Sovero
Class Notes
Economics, Taxes, Sovero, WFU
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This 3 page Class Notes was uploaded by Elina Doolabh on Wednesday February 24, 2016. The Class Notes belongs to Economics 150 at Wake Forest University taught by Dr. Veronica Sovero in Winter 2016. Since its upload, it has received 22 views. For similar materials see Introduction to Economics in Economcs at Wake Forest University.


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Date Created: 02/24/16
Taxes Economics 150 **Assume that these taxes can be paid by the buyer or the seller Can be a percent of the good’s price, or fixed amount per unit sold o Ex. (5 cents per can of soda) Graphically: - Supply: how much the sellers are willing to sell for - Demand: how much the buyers are willing to pay - Demand decreases by the amount of the tax Suppose there is a $20 tax per unit on buyers.  Buyers now have to pay more to complete a transaction - P = P + Tax - Buyers are less willing to pay the sellers for the good - Total willingness to pay hasn’t changed, only their willingness to pay the seller What to do graphically. 1. Draw the shift in the demand curve (for a tax on buyers) 2. What is the new equilibrium Q? ( Q Ta) 3. What are the prices after the tax? P = 20 P = P + Tax = 20 + 20 = 40 Change in Price? Befor Afte Change e r B P 30 40 Buyers pay +$10 per unit PS 30 20 Sellers receive -$10 per unit = $20 tax -both buyers and sellers are paying the tax  Splitting the tax burden evenly (50:50 split) Tax incidence: how much did the net price change for buyers vs. sellers? Taxes = source of revenue for the government How much tax revenue did the government collect as a result of this tax? Tax Revenue = Tax * Q T How would things change if we put a tax on sellers? Suppose there is a $20 tax on the sellers. S B P = P – Tax 1. Draw the shift in supply 2. Find new equilibrium (Q ) T 3. Find P and P B When you do the math you realize that you get the same result as when the buyers were being taxed.  It doesn’t matter who pays upfront, both the buyers and sellers share the burden of the tax - Regardless of the size of the tax, in the previous 2 scenarios, buyers and sellers split the tax burden evenly (50:50 split) Not always an evenly split: Ex. In the case where demand is more inelastic than supply, buyers bear the greater burden of the tax  For example, in an insulin market. Buyers HAVE to buy insulin. Sellers know this and charge more. - Key result: the side of the market (buyers or sellers) that is more inelastic will bear the greater burden of the tax Policy Examples: 1990: Congress Imposes tax on yachts, private jets, etc. (Luxury Tax)  Trying to redistribute wealth from rich  poor  Buyers are more elastic in (for example a private jet market) than sellers  Because of this, producers end up paying most of this tax since producers are more inelastic in this private jet market than on the buyers When does the tax burden fall entirely on one side? 1. Perfectly inelastic demand (something buyers need regardless of price) a. Buyers bear the whole tax b. Equilibrium quantity remains the same because demand is inelastic 2. Perfectly inelastic supply a. Sellers bear the whole tax b. Once again, equilibrium quantity remains the same When a market is taxed, prices change for buyers and sellers (tax incidence) - Equilibrium quantity after a tax is going to decrease  Must be creating a deadweight loss (fewer beneficial transactions between buyers and sellers compared to competitive equilibrium) Tax Revenue and the size of the Tax T DWL = ½ Tax(Equilibrium Quantity – Q ) If there is a larger tax: -Will tax revenue ↑? -Have to find a balance -What will happen to DWL? -Always increase -Larger tax results in a loss of more buyers What makes a DWL larger or smaller? - Buyers and sellers in an elastic market are very price sensitive. Makes sense to see large response to a tax in an elastic market.  will create a larger DWL (deadweight loss) - Inelastic market ≠ price sensitive  smaller DWL - Ex. Which market will have a larger DWL? o Cereal vs. sunscreen  Cereal has many substitutes available. Suggests that Demand is elastic  Sunscreen has fewer substitutes Equity vs. Efficiency - Tax groceries vs. tax fancy restaurant meals - To minimize DWL, tax groceries (efficient choice) - If our concern is equity, tax fancy restaurant meals Ex. NY sandwich tax - Tax on sandwiches, but no tax on unprepared tax  People are time constrained  buy sandwiches over ingredients  People who buy sandwiches are wealthier than people who make their own sandwiches So, what is a sandwich for the purposes of the tax? - Bagel with butter? Yes - Burrito? Yes - Open faced sandwich? Yes **Lots of money and resources spent determining what is a sandwich? Tax avoidance: generates incentives for people to try to avoid taxed goods (Pizza shops will sell cold pizza) Heat at home  not taxed (not technically prepared)


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