Lecture Notes: Economic Impacts of a Donut Tax

Introduction

• Exploration of tax effects on surpluses and tax revenue.
• Discussion of deadweight loss and its avoidance by governments.

Market Overview

• Demand Curve: No purchases above $6 per dozen.
• Supply Curve: No supply below $1 (minimum cost for low-cost producers).
• Equilibrium:
  • Price: $4
  • Quantity: 300 units

Introduction of Donut Tax

• Tax Amount: $1.50 production tax per unit.
• Effect on Supply Curve:
  • New supply curve includes tax.
  • Minimum price for suppliers to profit rises to $2.50.
• Price Wedge:
  • Buyers pay: $4.60
  • Sellers receive: $3.10
• Tax Burden:
  • Sellers bear more burden due to less elasticity in supply.

Effects on Surpluses

Consumer Surplus

• New Quantity Sold: 210 units
• Price Paid by Consumers: $4.60
• Calculation:
  • Formula: 1/2 × base × height
  • Base: 0 to 210
  • Height: $6 - $4.60 = $1.40
  • Consumer Surplus: $147
• Comparative Drop: Was $300, now $147
• Reasons:
  • Higher prices reduce demand.
  • Reduced consumer surplus for remaining buyers.

Producer Surplus

• Price Received by Sellers: $3.10
• Calculation:
  • 1/2 × base × height
  • Base: 210
  • Height: $3.10 - $1 = $2.10
  • Producer Surplus: $220.50
• Comparative Drop: Was $450, now $220.50
• Reasons:
  • Some suppliers exit market.
  • Reduced profits for continuing suppliers.

Tax Revenue

• Calculation:
  • $1.50 × 210 units = $315
• Use of Revenue: Supports public goods and government

Deadweight Loss

• Definition: Loss of economic activity after tax.
• Calculation:
  • 1/2 × (300 - 210) × ($4.60 - $3.10)
  • Result: $67.50
• Significance:
  • Represents loss for both consumers and producers.
  • Avoided by governments to prevent market distortion.

Conclusion

• Impact of tax on market dynamics depends on elasticity of demand and supply.
• Sensitivity to prices determines tax burden distribution.
• Goals: Minimize deadweight loss and maintain market efficiency.

Key Takeaway

• Sensitivity of market participants to price changes influences how the tax burden is shared.