Lecture Notes on Taxes and Market Effects

Summary

In today's lecture, Mr. Clifford discussed the impact of taxes on market equilibrium, consumer surplus, producer surplus, and the distribution of tax burdens between consumers and producers. He used the example of a per unit excise tax on milk to illustrate how taxes affect prices, market efficiency, and the way tax burdens are shared depending on the elasticity of demand and supply.

Key Concepts Explained

Excise Tax and Market Effects

• Excise Tax: A per unit tax imposed on producers which shifts the supply curve to the left.
• Example Used: Milk with an initial equilibrium price of $3 and a $2 per unit tax imposed.
• Effects on Prices:
  • The price paid by consumers increased to $4, but not by the full amount of the tax ($5), demonstrating how the tax burden is shared.
  • Producers receive only $2 from the $4 paid by consumers due to the $2 tax.

Tax Burden Distribution

• Allocation of the Tax:
  • Consumers pay an additional $1 per unit.
  • Producers effectively receive $1 less per unit.
• Tax Revenue: For milk, a tax results in $160 going to the government based on 80 units sold at a tax of $2 each.

Consumer and Producer Surplus

• Consumer Surplus: The area below the demand curve and above the price line, decreases as prices increase due to tax.
• Producer Surplus: The area above the supply curve and below the price line, also decreases when the supply curve shifts left due to tax.
• Deadweight Loss: Represents the loss of economic efficiency when the quantity of a good produced and consumed decreases due to a tax.

Elasticity and Tax Incidence

• Elasticity Impact on Tax Sharing:
  • When demand is perfectly inelastic, consumers bear the entire tax.
  • When demand is relatively inelastic, consumers bear a larger share of the tax.
  • When both demand and supply are equally elastic, the tax burden is equally shared.
  • When demand is more elastic than supply, producers bear more of the tax.
  • When demand is perfectly elastic, producers bear the entire tax.

Visual Analysis

• Graphical Representation:
  • Demonstrated tax effects through shifts in supply and demand curves.
  • Used different scenarios of elasticity to show who bears the majority of the tax burden.

Conclusion

Taxes critically alter the market dynamics including the prices, consumer and producer behaviour, and overall market efficiency. The incidence of a tax depends largely on the relative elasticities of supply and demand. Understanding these concepts is crucial for grasively grasping the broader economic implications of taxation in markets.