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Chapter 8 Notes

by: Devon Black

Chapter 8 Notes Econ 10A

Devon Black
Harvard University

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These notes cover taxation and its effects
Principles of Economics
N. Gregory Mankiw
Class Notes
Microeconomics, Taxes, taxation, Economics, supply side economics, deadweight_loss, deadweight-loss, deadweight, loss
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This 2 page Class Notes was uploaded by Devon Black on Friday September 23, 2016. The Class Notes belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 3 views. For similar materials see Principles of Economics in Economics at Harvard University.

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Date Created: 09/23/16
th Principles of Economics, 7 ed. Chapter 8: Application: The Costs of Taxations I) The Deadweight Loss of Taxation A) How a Tax Affects Market Participants 1) Benefit to consumers is measured by consumer surplus 2) Benefit to producers is measured by producer surplus 3) Benefit to government is measured by tax revenue (TxQ) (a) Can use to build roads, fund police, better education, etc. (b) Benefit actually ends up going to whomever the taxes are spent on (police, teachers, etc.), not to the government 4) Welfare without a Tax (a) 5) Welfare with a Tax 6) Changes in Welfare (a) Consumer surplus falls by area of B&C (b) Producer surplus falls by area D&E (c) Tax revenue rises by area B&D (d) Total surplus in market falls by area C&E (1) Losses to buyers and sellers from a tax exceed the revenue raised by the government (2) Fall in total surplus that results when a tax or other policy distorts a market outcome is called a deadweight loss (e) Why taxes impose deadweight losses (1) People respond to incentives (2) Free markets normally allocate resources efficiently (3) When the government imposes a tax, it raises the price buyers pay and lowers the price sellers receives (i) Incentive for buyers to consume less and for sellers to produce less (ii) Size of market shrinks below optimal size B) Deadweight Losses and the Gains from Trade 1) Taxes cause deadweight loss because they prevent buyers and sellers from realizing some of the gains from trade 2) Deadweight loss is the surplus that is lost because the tax discourages mutually advantageous trades II) Determinants of the Deadweight Loss A) Price elasticities of supply and demand determine how large the deadweight loss from a tax is B) Deadweight loss increases where curves are more elastic C) Case Study: The Deadweight Loss Debate III) Deadweight Loss and Tax Revenue as Taxes Vary A) As the size of the tax rises, so does the deadweight loss 1) Deadweight loss increases more rapidly, by a factor of 2 B) Case Study: The Laffer Curve and Supply-Side Economics 1) Upside-down parabola 2) To the right of the vertex, tax rates are so high that increasing them lowers tax revenue (a) If you’re on the right side of the curve, lowering taxes increases tax revenue 3) Supply-side economics are the economic ideas of Laffer and Reagan that cutting taxes would encourage people to increase the quantity of labor they supplied 4) Some tax payers may be on a different side of the Laffer Curve, from which they wouldn’t benefit from a tax cut 5) The more elastic supply and demand curves are in any market, the more taxes distort behavior and the more likely it is that a tax cut will increase tax revenue (a) Ultimately depends on how taxes change people’s behavior IV) Conclusion Vocabulary Deadweight Loss: the fall in total surplus that results from a market distortion, such as a tax Underground Economy: jobs whose salaries don’t pay taxes (e.g. under the table jobs, drug trade) Supply-side Economics: cutting taxes encourages people to increase the quantity of labor they supplied


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