In each of the following cases involving taxes, explain: (i)...

In each of the following cases involving taxes, explain: (i) whether the incidence of the tax falls more heavily on consumers or producers, (ii) why government revenue raised from the tax is not a good indicator of the true cost of the tax, and (iii) how deadweight loss arises as a result of the tax. a. The government imposes an excise tax on the sale of all college textbooks. Before the tax was imposed, 1 million textbooks were sold every year at a price of \$50. After the tax is imposed, 600,000 books are sold yearly; students pay $\$ 55$ per book, $\$ 30$ of which publishers receive. b. The government imposes an excise tax on the sale of all airline tickets. Before the tax was imposed, 3 million airline tickets were sold every year at a price of $\$ 500$. After the tax is imposed, 1.5 million tickets are sold yearly; travelers pay $\$ 550$ per ticket, $\$ 450$ of which the airlines receive. c. The government imposes an excise tax on the sale of all toothbrushes. Before the tax, 2 million toothbrushes were sold every year at a price of $\$ 1.50$. After the tax is imposed, 800,000 toothbrushes are sold every year; consumers pay $\$ 2$ per toothbrush, $\$ 1.25$ of which producers receive.

In each of the following cases involving taxes, explain:
(i) whether the incidence of the tax falls more heavily on consumers or producers,
(ii) why government revenue raised from the tax is not a good indicator of the true cost of the tax, and (iii) how deadweight loss arises as a result of the tax.
a. The government imposes an excise tax on the sale of all college textbooks. Before the tax was imposed, 1 million textbooks were sold every year at a price of \$50. After the tax is imposed, 600,000 books are sold yearly; students pay $\$ 55$ per book, $\$ 30$ of which publishers receive.
b. The government imposes an excise tax on the sale of all airline tickets. Before the tax was imposed, 3 million airline tickets were sold every year at a price of $\$ 500$. After the tax is imposed, 1.5 million tickets are sold yearly; travelers pay $\$ 550$ per ticket, $\$ 450$ of which the airlines receive.
c. The government imposes an excise tax on the sale of all toothbrushes. Before the tax, 2 million toothbrushes were sold every year at a price of $\$ 1.50$. After the tax is imposed, 800,000 toothbrushes are sold every year; consumers pay $\$ 2$ per toothbrush, $\$ 1.25$ of which producers receive.

Key Concepts

Government Revenue vs. True Cost

The revenue collected from a tax is simply the product of the tax rate and the number of units sold, but it does not capture the full economic impact of the tax. Specifically, the government revenue does not reflect the inefficiencies introduced into the market, such as the reduced number of transactions. Thus, while tax revenue is often used as an indicator of the tax's impact, it fails to account for the additional social costs imposed by the tax, which include the lost welfare from transactions that no longer occur at the new equilibrium.

Deadweight Loss

Deadweight loss refers to the loss of economic efficiency that occurs when a tax or any market distortion leads to a reduction in the quantity of a good traded compared to the market equilibrium. This loss represents value that neither accrues to consumers, producers, nor the government as revenue. Deadweight loss is generated because the tax prevents mutually beneficial transactions from taking place, resulting in a net loss in total societal welfare and causing a misallocation of resources relative to the optimal market outcome.

Elasticity of Demand and Supply

Elasticity is a measure of how much quantity demanded or supplied responds to changes in price. In the context of taxation, the elasticities of demand and supply determine both the extent to which the tax burden is shifted between consumers and producers and the resulting change in market transactions. When either supply or demand is relatively inelastic, that side of the market is less willing or able to change its behavior in response to price changes, leading to a higher tax burden on that side and a smaller change in the quantity traded.

Tax Incidence

Tax incidence refers to the study of who ultimately bears the burden of a tax – consumers or producers. This concept is not determined solely by who is legally responsible for paying the tax, but rather by the relative elasticities of supply and demand. The side of the market (either consumers or producers) that is less responsive to price changes tends to bear a larger share of the tax burden, meaning that even when the tax is levied on one group, the economic burden is distributed throughout the market based on how each group adjusts its behavior in response to price changes.

Transcript

00:02 We have three different situations where taxes are imposed, and we're supposed to figure out which side of the market bears most of the burden of the tax and why government revenue doesn't reflect the full cost of the tax and how does dead weight loss happen because of the tax.

00:27 So in the first case, we've got a tax on textbooks.

00:32 And so to show the impact of that tax, we'll drive demand and supply curves.

00:38 Here's our demand.

00:41 And here's our supply.

00:44 And it says that initially people paid $50 for textbooks.

00:50 But then a tax was imposed, which brought the price up for consumers to $55.

00:56 $35 and the price that the producers received after the tax was $30.

01:11 So in this case, the burden for consumers was $5 because they're paying 55 versus 50 before the tax.

01:23 But most of the burden falls on producers because they were getting $50 before the tax and now after the tax, the producer's burden, their own.

01:34 Only getting 30, so producers burden would be 20.

01:38 Now, our government revenue, if we look at the quantities that we started and ended with, initially we were selling a million textbooks.

01:51 After the tax, though, our quantity is decreased down to 600 ,000.

02:01 So our government revenue would be that 600 ,000 books sold times the amount of the amount of the money.

02:08 Tax.

02:09 We know that the amount of the tax is $25 because the difference between the price consumers pay and the price that the producers receive after the taxes pay, that difference between 55 and 30 is $25.

02:28 So our government revenue would be 25 ,000 times 600 ,000 books, which works out to be $15 million.

02:42 But there's cost to that tax and that's in the dead weight loss.

02:47 The dead weight loss is due to the fact that we've got 400 ,000 books that aren't being sold and we've got people that are willing to pay and producers that are willing to sell in the absence of the tax.

03:02 So our dead weight loss would be that difference between what the consumers pay and what the producers receive and the fact that the quantity bought and sold has decreased by 400 ,000.

03:27 So part b is a similar question.

03:30 It's just a different market.

03:32 In part b, the government puts an excise tax on airline tickets.

03:38 And before the tax, we were selling three million tickets.

03:46 Put our demand and supply curves in...

Please give Ace some feedback