Difficult Topics in Microeconomics: Tax analysis

Luis Fernandez

And

Teresa Fischer

Teaching Objectives of Tax Analysis

Application of supply and demand analysis. Refute the “fly-paper theory” of tax incidence. Determine the welfare effects of a well-

known type of public policy - taxation. Relate tax incidence to demand and supply

elasticities.

Analysis of a $1/unit excise tax

Typical Supply and Demand Diagram

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Quantity Supplied and Demanded

Pri

ce

(p

aid

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rs)

Supply

Demand

A $1/unit excise tax is enacted

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Quantity Supplied and Demanded

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ce

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aid

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Supply

Demand

What happens to the demand curve?

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ce

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aid

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Nothing happens to the demand curve!

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Quantity Supplied and Demanded

Pri

ce

(p

aid

by

bu

ye

rs)

Supply

Demand

What happens to the supply curve?

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$1

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Quantity Supplied and Demanded

Pri

ce

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aid

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bu

ye

rs)

Supply

Demand

The supply curve shifts up by $1/unit!

Result: price paid by buyers goes up and quantity sold goes down

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Quantity Supplied and Demanded

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ce

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Supply

Demand

Result: price paid by buyers goes up by LESS than the tax!

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Supply

Demand

Welfare Analysis

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Supply

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Producer surplus

Consumer surplus

Welfare Effect of tax: consumer surplus falls

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New consumer surplus

Old consumer surplus

Welfare Effect of tax: producer surplus falls

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New producer surplus

Old producer surplus

Welfare effect of tax:tax revenue goes up

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ce

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Supply

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Tax revenue

Welfare effect of tax:fall in surplus is greater than tax

revenue

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Supply

DemandTax revenue

Consumer Surplus

Producer Surplus

Welfare effect of tax: total welfare goes down

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Quantity Supplied and Demanded

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Supply

Demand

“Dead-weight” loss of tax

Consumer and Producer Surplus and Tax Revenue