Intro to Food and Resource Economics - Week 8
Intro to Food and Resource Economics - Week 8 2713
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This 10 page Class Notes was uploaded by Taylor Baker on Thursday October 6, 2016. The Class Notes belongs to 2713 at Mississippi State University taught by Danny Barefield in Fall 2016. Since its upload, it has received 4 views. For similar materials see Intro to Food & Resource Econ in agricultural economics at Mississippi State University.
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Date Created: 10/06/16
Intro to Food and Resource Economics Week 8 - October 3 - 7, 2016 Chapter 8 continued… Analysis of a tax: A. compute the consumer surplus, producer surplus and total surplus without a tax. B. if the government implements a $100 tax per ticket, compute the consumer surplus, producer surplus, tax revenue, total surplus and deadweight loss. Answers to A - Consumer surplus = ½ x $200 x 100 = $10,000 - Producer Surplus = ½ x $200 x 100 = $10,000 - Total Surplus = $10,000 + $10,000 = $20,000 Answers to B ($100 excise tax) - Consumer surplus (area A) = ½ x $150 x 75 = $5,625 - Producer Surplus (area F) = ½ x $150 x 75 = $5,625 - Tax Revenue (areas B + D) = $100 x 75 = $7,500 - Total Surplus (areas A + B + D +F) = $5,625 + $5,625 + $7,500 = $18,750 - Dead Weight Loss (areas C + E) = ½ x $50 x 25 + ½ x $50 x 25 = $625 + $625 = $1,250 Welfare effects of a tax: - Consumer Surplus before tax = A+B+C+D+E - Consumer Surplus after tax = A+B - Producer Surplus before tax = F+G+H+I - Producer Surplus after tax = I - Tax Revenue = C+D+F+G - Beneﬁt to Society (total surplus) = A+B+C+D+F+G+I - Dead weight loss = E+H What determines the size of the deadweight loss: - Which goods or services should government tax to raise the revenue that it needs for public services? ▪ One answer: Those with the smallest dead weight loss • When is the dead weight loss small vs large? It depends on the price elasticities of supply and demand ▪ • Recall that the price elasticity of demand (or supply) measures how much Quantity Demanded or Quantity Supplied changes when Price changes. Deadweight loss and the elasticity of supply: - When supply is inelastic, it’s harder for firms to leave the market when the tax reduces the price for producers - So the tax only reduces quantity a relatively small amount and the dead weight loss is relatively small. - When supply is more elastic, it’s harder for firms to leave the market when the tax reduces the price for producers. - So the tax reduces quantity a relatively large amount and the dead weight loss is relatively large. Deadweight loss and the elasticity of demand: - When demand is inelastic, it’s harder for consumers to leave the market when the tax increases the price for buyers. - So the tax only reduces quantity a relatively small amount and the dead weight loss is relatively small. - When demand is more elastic, it’s easier for consumers to leave the market when the tax increases the price for buyers. - So the tax reduces quantity a relatively large amount and the dead weight loss is relatively large. How big should government be? - A bigger government can provide more services, but requires higher taxes. This causes larger dead weight losses. - The larger the dead weight loss from taxation, the stronger the argument for smaller government. - The tax on labor income (income tax) is especially important; it’s the largest source of government revenue. - For the typical worker, the marginal tax rate (the tax rate on the last dollar of earnings) is about 40% How big is the dead weight loss from this tax? It depends on elasticity … - If the labor supply is inelastic , then this dead weight loss is small - Some economists believe labor supply is inelastic, arguing that most workers work full-time regardless of the wage - Other economists believe that taxes are highly distorting because some groups of works have an elastic supply and can respond to incentives. – Many workers can adjust their hours (e.g., by working overtime) nd – Many families have a 2 earner with discretion over whether and how much to work – Many elderly choose when to retire based on the wage they earn – Some people work in the “underground economy” to avoid (high) taxes The effects of changing the size of the tax: - policy makers often change taxes, raising some and lowering others - what happens to the dead weight loss and the tax revenue when taxes change? The deadweight loss and the size of the tax: - initially, the tax is denoted by Tax per unit - doubling the tax causes the deadweight loss to mote than double - Tripling the tax causes the dead weight loss to more than triple - Implication - When tax rates are low, raising them doesn’t cause much harm, and lowering them doesn’t bring much benefit. - When tax rates are high, raising them is very harmful, and cutting them is very beneficial. Revenue and the size of tax: - Initial tax revenue is shown as the yellow rectangle bounded by P , P and Q BT ST ST - Doubling the tax causes tax revenue to be defined as the teal rectangle bounded by P , P and Qs2t B2T S2T - In this case, total tax revenue seems to increase with the larger tax - Initial tax revenue is shown as the yellow rectangle bounded by P , P and Q BT ST ST - Tripling the tax causes tax revenue to be defined as the teal rectangle bounded by P , P and Qs3t B3T S3T - In this case, total tax revenue seems to decrease with the larger tax - The Laffer Curve shows the relationship between the size of the tax and the total amount of tax revenue - What determines the point of maximum tax revenue (Rev )? MAX - Elasticities of supply and demand Summary: - A tax on a good reduces the welfare of buyers and sellers. This welfare loss usually exceeds the revenue the tax raises for the government (at least when demand and supply are both relatively elastic). - The fall in total surplus (consumer surplus, producer surplus and tax revenue) is called the dead weight loss of the tax. - A tax has a dead weight loss because it causes consumers to buy less and producers to sell less, thus shrinking the market below the level that maximizes total surplus. - The price elasticities of demand and supply measure how much buyers and sellers respond to price changes. Therefore, higher elasticities imply higher dead weight losses. - An increase in the size of a tax causes the dead weight loss to rise even more. - An increase in the size of a tax causes revenue to rise at first, but eventually revenue falls because the tax reduces the size of the market. - higher elasticity higher deadweight loss - not going to be tested on the Laffer curve but know the term - the measure of how you react to any market is called elasticity
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