1. Taxes & Market Equilibrium
Chapter 6

2. How Taxes on Buyers (and Sellers) Affect Market Outcomes
When a good is taxed, the quantity sold is smaller
Buyers and sellers both share the tax burden
Types of Taxes:
Sales Tax: tax on most goods (usually % of price)
Excise Tax: taxes on specific goods (ex: cigarettes, gasoline, etc…)
Why tax?
To raise Government Revenue or
To decrease consumption of a good (cigarettes) 22 30

3. Elasticity & Tax Incidence
Tax incidence is the study of who bears the burden of a tax
Taxes always result in a change in market equilibrium
Buyers pay more & sellers receive less
regardless of whom the tax is levied on! 21 31

4. Example: Tax on Sellers
Government places a tax on ice cream of .50 cents
Does the tax shift the supply or demand curve?
Demand Curve is not affected
Determinant of demand did not change (TIPSEN )
Supply Curve will shift left
Taxes is a determinant of supply (TINE & TP)

5. Tax on Sellers Price of Ice-Cream Demand, D1 Price buyers pay Cone S2
A tax on sellers
shifts the supply
curve upward
by the amount of
the tax ($0.50).
Price
buyers
pay
Cone S2
Equilibrium
with tax S1
$3.30 90
Tax ($0.50)
TINE & TP
Taxes are a
Determinant of supply
Price
without
tax
3.00
100
Equilibrium without tax
2.80
Price
sellers
receive
Quantity of
Ice-Cream Cones

6. Tax on Buyers Price of Ice-Cream Price buyers pay Supply, S1 Cone D1
$3.30 90
Equilibrium without tax
Tax ($0.50)
Price
without
tax
3.00
100
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).
2.80
New Equilibrium
with tax
Price
sellers
receive
Quantity of
Ice-Cream Cones

7. Elasticity determines Tax Incidence
In what proportions is the burden of the tax divided?
How do the effects of taxes on sellers compare to those levied on buyers?
It depends on the elasticity of demand & the elasticity of supply 29 39

8. Inelastic Demand (a) Inelastic Demand, Elastic Supply Price
1. When supply is more elastic
than demand . . .
Demand
Price buyers pay
Tax
the
incidence of the
tax falls more
heavily on
consumers . . .
Supply
Price without tax
than
on producers.
Price sellers
receive
Quantity

9. Inelastic Supply (b) Inelastic Supply, Elastic Demand Price
1. When demand is more elastic
than supply . . .
Demand
Price buyers pay
Supply
Tax
than on
consumers.
Price without tax
the
incidence of
the tax falls
more heavily
on producers . . .
Price sellers
receive
Quantity

10. So, how is the burden of the tax divided?
The burden of a tax falls more heavily on the side that is less elastic D S
The Steeper Curve
pays more tax! 30 41

11. Tax Summary A tax on buyers shifts D-curve
A tax on sellers shifts S-Curve
The incidence of a tax does not depend on whether the tax is levied on buyers or sellers
It depends on the price elasticities of supply and demand.
The majority of the tax burden falls on the side of the market that is less elastic (more inelastic, steeper curve pays more of tax)

12. Worksheet on Excise Taxes
Lesson 4, Activity 21

13. Perfectly Inelastic Demand
Tax
Revenue
Tax P1 Q1