Does Medicare Part B Premium Change Every Year Based On Income
Topic 4 Office 2: Applications of Supply and Need
4.7 Taxes and Subsidies
Learning Objectives
By the end of this section, y'all will be able to:
- Distinguish betwixt legal and economic tax incidence
- Know how to correspond taxes by shifting the bend and the wedge method
- Empathize the quantity and price affect from a tax
- Describe why both taxes and subsidies cause deadweight loss
Taxes are not the almost pop policy, but they are oft necessary. We volition look at 2 methods to understand how taxes affect the market: past shifting the curve and using the wedge method. First, we must examine the departure between legal tax incidence and economic tax incidence.
Legal versus Economical Tax Incidence
When the regime sets a tax, information technology must determine whether to levy the revenue enhancement on the producers or the consumers. This is calledlegal tax incidence. The most well-known taxes are ones levied on the consumer, such as Government Sales Tax (GST) and Provincial Sales Tax (PST). The government also sets taxes on producers, such equally the gas revenue enhancement, which cuts into their profits. The legal incidence of the tax is actually irrelevant when determining who is impacted by the tax. When the regime levies a gas taxation, the producers will pass some of these costs on as an increased cost. Likewise, a tax on consumers will ultimately decrease quantity demanded and reduce producer surplus. This is considering the economic taxation incidence, or who actually pays in the new equilibrium for the incidence of the revenue enhancement, is based on how the market responds to the price alter – not on legal incidence.
Taxation – Shifting the Curve
In Topic 3, we adamant that the supply bend was derived from a firm'south Marginal Cost and that shifts in the supply curve were caused by whatever changes in the market that caused an increase in MC at every quantity level. This is no different for a tax. From the producer's perspective, any revenue enhancement levied on them is just an increase in the marginal costs per unit. To illustrate the effect of a revenue enhancement, allow's look at the oil market again.
If the government levies a $3 gas tax on producers (a legal taxation incidence on producers), the supply bend volition shift upwards past $3. Every bit shown in Figure iv.8a below, a new equilibrium is created at P=$5 and Q=two 1000000 barrels. Notation that producers do not receive $5, they now only receive $2, as $3 has to be sent to the government. From the consumer'south perspective, this $1 increase in toll is no different than a cost increase for any other reason, and responds by decreasing the quantity demanded for the higher priced good.
What if the legal incidence of the tax is levied on the consumers? Since the need curve represents the consumers' willingness to pay, the need bend volition shift down equally a result of the tax. If consumers are only willing to pay $4/gallon for four one thousand thousand gallons of oil but know they will confront a $3/gallon revenue enhancement at the till, they will only buy iv million gallons if the ticket price is $1. This creates a new equilibrium where consumers pay a $2 ticket cost, knowing they volition have to pay a $3 tax for a total of $v. The producers will receive the $2 paid before taxes.
Notation that whether the tax is levied on the consumer or producer, the final upshot is the aforementioned, proving the legal incidence of the tax is irrelevant.
Taxation – The Wedge Method
Another method to view taxes is through the wedge method. This method recognizes that who pays the tax is ultimately irrelevant. Instead, the wedge method illustrates that a tax drives a wedge betwixt the price consumers pay and the revenue producers receive, equal to the size of the taxation levied.
Every bit illustrated below, to discover the new equilibrium, one simply needs to find a $iii wedge between the curves. The first wedge tested is only $0.seven, followed past $ane.5, until the $3.0 tax is found.
Market place Surplus
Similar with price and quantity controls, 1 must compare the market surplus before and after a price modify to fully sympathise the furnishings of a tax policy on surplus.
Before
The market surplus before the tax has not been shown, as the process should be routine. Ensure you lot understand how to get the following values:
Consumer Surplus= $four million
Producer Surplus = $8 1000000
Market Surplus = $12 meg
After
The market surplus later on the policy can be calculated in reference to Effigy 4.7d
Consumer Surplus (Blue Area) = $1 million
Producer Surplus (Red Area)= $2 1000000
Government Acquirement (Green Area) = $vi 1000000
Market Surplus= $ix 1000000
Why is Government Included in Market Surplus
In our previous examples dealing with market surplus, nosotros did not include whatever discussion of government revenue, since the government was not engaging in our market. Remember that market place surplus is our metric for efficiency. If government was not included in this metric, it would not be very useful. In this case a million-dollar loss to government would exist considered efficient if information technology resulted in a $one proceeds to a consumer. To ensure that our metric for efficiency is nevertheless useful nosotros must consider government when calculating market surplus.
As with the quota – both consumer and producer surplus decreased because of a reduced quantity. The difference is, since the price is changing, at that place is redistribution. This time, the redistribution is from consumers and producers to the government. Remember, but a modify in quantity causes a deadweight loss. Price changes only shift surplus around between consumers, producers, and the government.
Transfer and Deadweight Loss
Let'southward look closely at the tax's impact on quantity and cost to see how these components affect the market.
Transfer – The Touch of Price
Due to the tax's effect on price, areas A and C are transferred from consumer and producer surplus to government revenue.
Consumers to Regime – Area A
Consumers originally paid $four/gallon for gas. At present, they are paying $5/gallon. The $i increase in price is the portion of the tax that consumers have to behave. Despite the fact that the revenue enhancement is levied on producers, the consumers take to bear a share of the price change. The size of this share depends on relative elasticity – a concept we will explore in the next department. This is because a subtract in price to producers means quantity supplied is falling, and in lodge to maintain equilibrium, quantity demanded must fall by an equal corporeality. This price change means the government collects $1 x 2 million gallons or $two million in tax revenue from the consumers. This is a straight transfer from consumers to government and has no effect on market surplus.
Producers to Government – Area C
Originally, producers received revenue of $4/gallon for gas. Now, they receive $ii/gallon. This $2 subtract is the portion of the tax that producers have to bear. This ways that the government collects $ii 10 two million gallons or $4 meg in taxation acquirement from the producers. This is a transfer from producers to the government.
Every bit calculated, the government receives a total of $6 1000000 in tax revenue, which is taken from consumers and producers. This has no impact on internet market surplus.
Deadweight Loss – The Impact of Quantity
If we just considered a transfer of surplus, at that place would be no deadweight loss. In this case, though, we know that price changes come up with a change in quantity. A higher price for consumers volition cause a decrease in the quantity demanded, and a lower price for producers will cause a decrease in quantity supplied. This reduction from equilibrium quantity is what causes a deadweight loss in the market since in that location are consumers and producers who are no longer able to buy and supply the good.
Consumer Surplus Decrease – Area B
Due to the increase in toll, many consumers volition switch away from oil to alternative options. This decrease in quantity demand of one.5 million gallons of oil causes a deadweight loss of $i 1000000.
Producer Surplus Subtract – Area D
Producers, who now receive simply $2.00/gallon for their production, will also decrease quantity supplied by 1.5 million gallons of oil. It is no coincidence that the size of the subtract is the same. When y'all create the wedge between consumers and producers, you are finding the quantity where the full amount of the tax is incurred but the market place is still at equilibrium. Call back that quantity demanded must equal quantity supplied or the marketplace will not be stable. This mirrored decrease in quantity ensures this is even so the case. Notice, however, that the impact of this quantity drop causes a larger decrease in producer surplus than consumer surplus totalling $two million. Again, this is due to elasticity, or the relative responsiveness to the price gamble, which will be explored in more detail shortly.
Together, these decreases crusade a $3 million deadweight loss (the difference between the market surplus before and market surplus after).
Subsidy
While a tax drives a wedge that increases the price consumers accept to pay and decreases the price producers receive, a subsidy does the opposite. Asubsidy is a benefit given by the authorities to groups or individuals, usually in the form of a cash payment or a tax reduction. A subsidy is often given to remove some type of burden, and it is oft considered to be in the overall interest of the public. In economic terms, a subsidy drives a wedge, decreasing the price consumers pay and increasing the price producers receive, with the government incurring an expense.
In Topic 3, we looked at a instance report of Victoria's competitive housing market where high need drove upward prices. In response, the regime has enacted many policies to allow low-income families to still become homeowners. Let's look at the effects of one possible policy. (Note the following policy is unrealistic but allows for easy comprehension of the issue of subsidies).
In the market above, our efficient equilibrium begins at a price of $400,000 per home, with 40,000 homes being purchased. The government wants to substantially increase the number of consumers able to purchase homes, then information technology problems a $300,000 subsidy for any consumers purchasing a new abode. This drives a wedge betwixt what abode buyers pay ($250,000) and what home builders receive ($550,000).
With all government policies we take examined so far, nosotros take wanted to determine whether the result of the policy increases or decreases market surplus. With a subsidy, we desire to practise the same assay. Unfortunately, because increases in surplus overlap on our diagram, it becomes more complicated. To simplify the analysis, the following diagram separates the changes to producers, consumers, and government onto different graphs.
Producers
The producers now receive $550,000 instead of $400,000, increasing quantity supplied to 60,000 homes. This increases producer surplus byareas A and B.
Consumers
The consumers at present pay $250,000 instead of $400,000, increasing quantity demanded to 60,000 homes. This increases consumer surplus byareas C and D.
Government
The government now has to pay $300,000 per home to subsidize the 60,000 consumers buying new homes (this policy would cost the authorities $18 billion!!) Graphically, this is equal to a subtract in government to areas A, B, C, D and E.
Effect
Our total gains from the policy (to producers and consumers) are areasA, B, C and D,whereas total losses (the cost to the government) are areasA, B, C, D, and Eastward.To summarize:
AreasA, B, C and D are transferred from the government to consumers and producers.
Area Due east is a deadweight loss from the policy.
At that place are ii things to notice about this example. Offset, the policy was successful at increasing quantity from forty,000 homes to 60,000 homes. 2nd, it resulted in a deadweight loss because equilibrium quantity was likewise loftier. Remember,anytime quantity is changed from the equilibrium quantity, in the absence of externalities, at that place is a deadweight loss. This is true for when quantity is decreased and when information technology is increased.
http://www.investopedia.com/terms/southward/subsidy.asp
Summary
Taxes and subsidies are more complicated than a price or quantity control every bit they involve a third economic actor: the government. As we saw, who the tax or subsidy is levied on is irrelevant when looking at how the market ends upwards. Annotation that the final three sections accept painted a fairly grim picture virtually policy instruments. This is considering our model currently does non include the external costs economic players impose to the macro-environment (pollution, disease, etc.) or attribute any meaning to equity. These concepts will be explored in more than item in later topics.
In our examples to a higher place, we run across that the legal incidence of the tax does not thing, simply what does? To make up one's mind which party bears more than of the burden, we must apply the concept of relative elasticity to our analysis.
Glossary
- Economic Revenue enhancement Incidence
- the distribution of tax based on who bears the burden in the new equilibrium, based on elasticity
- Legal Tax Incidence
- the legal distribution of who pays the tax
- Subsidy
- a benefit given past the government to groups or individuals, usually in the form of a cash payment or a tax reduction It is often to remove some type of brunt, and it is often considered to exist in the overall interest of the public
Exercises 4.7
Refer to the supply and need curves illustrated beneath for the following 3 questions. Consider the introduction of a $20 per unit tax in this market place.
1. Which areas correspond the loss to consumer AND producer surplus as a result of this tax?
a) thousand + f.
b) j + g.
c) 1000 + j.
d) chiliad + f + j + g.
two.Which areas represent the gain in authorities revenue as a result of this tax?
a) grand + f.
b) j + yard.
c) one thousand + j.
d) k + f + j + g.
3. Which areas represent the deadweight loss associated with this tax?
a) f + thousand.
b) k – chiliad.
c) j – f.
d) k + f + j + g.
4. Assume that the marginal cost of producing socks is constant for all sock producers, and is equal to $5 per pair. If authorities introduces a constant per-unit tax on socks, then which of the following statements is Simulated, given the later on-revenue enhancement equilibrium in the sock marketplace? (Presume a downward-sloping demand curve for socks.)
a) Consumers are worse off as a result of the taxation.
b) Spending on socks may either increase or decrease as a effect of the tax.
c) Producers are worse off as a upshot of the tax.
d) This tax volition issue in a deadweight loss.
v. Refer to the supply and need diagram below.
If an subsidy of $3 per unit of measurement is introduced in this market, the price that consumers pay will equal ____ and the toll that producers receive internet of the subsidy will equal _____.
a) $two; $5.
b) $3; $6.
c) $iv; $7.
d) $5; $8.
6. If a subsidy is introduced in a market, and then which of the following statement is TRUE? Assume no externalities
a) Consumer and producer surplus increase but social surplus decreases.
b) Consumer and producer surplus decrease merely social surplus increases.
c) Consumer surplus, producer surplus, and social surplus all increase.
d) Consumer surplus, producer surplus, and social surplus all subtract
Use the diagram below to answer the following TWO questions.
7. If a $6 per unit tax is introduced in this market place, then the price that consumers pay volition equal ____ and the price that producers receive net of the tax will equal _____.
a) $10; $4.
b) $9; $3.
c) $viii; $2.
d) $7; $1.
8. If a $6 per unit of measurement tax is introduced in this market, and then the new equilibrium quantity will be:
a) 20 units.
b) twoscore units.
c) 60 units.
d) None of the above.
9. Which of the post-obit statements about the deadweight loss of taxation is TRUE? (Assume no externalities.)
a) If there is a deadweight loss, and then the revenue raised past the tax is greater than the losses to consumer and producers.
b) If there is no deadweight loss, then revenue raised by the government is exactly equal to the losses to consumers and producers.
c) Both a) and b).
d) Neither a) nor b).
10. Which of the following correctly describes the equilibrium effects of a per-unit tax, in a marketplace with NO externalities?
a) Consumer and producer surplus increase but social surplus decreases.
b) Consumer and producer surplus decrease but social surplus increases.
c) Consumer surplus, producer surplus, and social surplus all increase.
d) Consumer surplus, producer surplus, and social surplus all decrease.
11. Which of the following correctly describes the equilibrium furnishings of a per unit subsidy?
a) Consumer price rises, producer toll falls, and quantity increases.
b) Consumer toll falls, producer price falls, and quantity increases.
c) Consumer price rises, producer price rises, and quantity increases.
d) Consumer price falls, producer cost rises, and quantity increases.
12. Refer to the supply and demand diagram below.
If an output (excise) tax of $5 per unit of measurement is introduced in this market, the toll that consumers pay will equal ____ and the cost that producers receive cyberspace of the revenue enhancement will equal _____.
a) $5; $ten.
b) $6; $11.
c) $vii; $12.
d) $8; $three.
xiii. Consider the supply and need diagram beneath.
If a $2 per unit subsidy is introduced, what will be the equilibrium quantity?
a) forty units.
b) 45 units.
c) 50 units.
d) 55 units.
Consider the supply and demand diagram below. Presume that: (i) there are no externalities; and (ii) in the absence of government regulation the market supply bend is the one labeled S1.
fourteen. If a $v per unit tax is introduced in this market, which area represents the deadweight loss?
a) a.
b) a + b.
c) b + c.
d) a + b + c.
Source: https://pressbooks.bccampus.ca/uvicecon103/chapter/4-6-taxes/
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