2. Taxes and welfareslide 1 Taxes and Welfare In this section, we examine the effects on welfare of changes in excise taxes. The approach taken here, is to use the devices of Producer and Consumer Surplus. The social welfare from the production and consumption of a particular amount of a good is the sum of the producer surplus, consumer surplus, and any tax revenue taken in by the government.

3. Taxes and welfareslide 2 S D Q P Q* P* What are the welfare effects of an excise tax on beer? BEER MARKET

4. Taxes and welfareslide 3 d D Q P Q* P* CHANGE IN CS = -a - b CHANGE IN PS = -c - d TAX REVENUE OF GOV'T = a + c So social cost = b + d BEER MARKET S + t TAX PER UNIT b a c S

5. Taxes and welfareslide 4 Economists call the loss in social welfare due to the tax THE DEADWEIGHT LOSS from the tax.

6. Taxes and welfareslide 5 Illustrating the deadweight loss The following hidden slide shows the changes in surplus and the deadweight loss due to an excise tax. Hidden slide

7. Taxes and welfareslide 6 What happens to welfare when an excise tax is put on a good? D Q0Q0 S D Q0Q0 S PP Q Q P' Starting consumer surplus Starting producer surplus New consumer surplus New producer surplus S + t P' - t Tax revenueDeadweight loss

8. Taxes and welfareslide 7 The size of the deadweight loss is determined by 1) The elasticity of the demand curve. 2) The elasticity of the supply curve. 3) The amount of the tax per unit.

9. Taxes and welfareslide 8 The following hidden slide shows the effect of demand elasticity on the size of the deadweight loss in welfare due to an excise tax. Hidden slide

10. Taxes and welfareslide 9 S D elast D inelast S Q Q $/Q Equal Pretax Sales The more elastic the demand curve, the greater is the deadweight loss. S+Tax Larger deadweight loss Smaller deadweight loss

11. Taxes and welfareslide 10 Economists use terms such as "distortion of the market" to describe the loss. The deadweight loss is an example of an economic inefficiency.

12. Taxes and welfareslide 11 The following hidden slide shows the effect of supply elasticity on the deadweight loss due to a tax. Hidden slide

13. Taxes and welfareslide 12 S inelas D D S elas Q Q $/Q Equal Pretax Sales The more elastic the supply curve, the greater is the deadweight loss. S inelas +Tax S elas +Tax Larger deadweight loss Smaller deadweight loss

14. The following hidden slide shows the effect of demand elasticity on the government’s tax revenue. Hidden slide

15. Taxes and welfareslide 14 S D elast D inelast S Q Q $/Q Equal Pretax Sales The more elastic the demand curve, the smaller is tax revenue. S+Tax Larger tax revenue Smaller tax revenue

16. Taxes and welfareslide 15 Notice that this analysis can also be applied to subsidies: A per unit subsidy will create a DEADWEIGHT LOSS in social welfare. In the case of the subsidy too much of society's resources will be devoted to the good.