Taxes on Adult Family Home With High Risk Patients
Topic 4 Part ii: Applications of Supply and Demand
iv.7 Taxes and Subsidies
Learning Objectives
Past the end of this department, you will be able to:
- Distinguish between legal and economic tax incidence
- Know how to represent taxes by shifting the curve and the wedge method
- Understand the quantity and price impact from a tax
- Describe why both taxes and subsidies cause deadweight loss
Taxes are not the well-nigh pop policy, but they are often necessary. We will look at two methods to sympathise how taxes touch on the market: by shifting the curve and using the wedge method. First, we must examine the difference between legal revenue enhancement incidence and economic tax incidence.
Legal versus Economic Tax Incidence
When the government sets a tax, it must decide whether to levy the tax on the producers or the consumers. This is calledlegal tax incidence. The most well-known taxes are ones levied on the consumer, such equally Regime Sales Tax (GST) and Provincial Sales Revenue enhancement (PST). The authorities as well sets taxes on producers, such as the gas tax, which cuts into their profits. The legal incidence of the tax is actually irrelevant when determining who is impacted by the taxation. When the government levies a gas taxation, the producers will pass some of these costs on as an increased price. Likewise, a tax on consumers will ultimately subtract quantity demanded and reduce producer surplus. This is because the economical taxation incidence, or who actually pays in the new equilibrium for the incidence of the tax, is based on how the market responds to the price change – not on legal incidence.
Tax – Shifting the Curve
In Topic 3, we adamant that the supply curve was derived from a firm'south Marginal Cost and that shifts in the supply bend were caused by whatsoever changes in the market that acquired an increase in MC at every quantity level. This is no different for a tax. From the producer'due south perspective, any revenue enhancement levied on them is just an increase in the marginal costs per unit. To illustrate the consequence of a tax, let's look at the oil marketplace over again.
If the government levies a $3 gas revenue enhancement on producers (a legal tax incidence on producers), the supply curve volition shift upward by $3. Equally shown in Figure 4.8a below, a new equilibrium is created at P=$5 and Q=two million barrels. Note that producers do not receive $five, they at present only receive $2, every bit $3 has to be sent to the government. From the consumer'southward perspective, this $1 increment in price is no different than a cost increase for whatsoever other reason, and responds by decreasing the quantity demanded for the higher priced proficient.
What if the legal incidence of the tax is levied on the consumers? Since the demand curve represents the consumers' willingness to pay, the demand curve will shift down every bit a result of the tax. If consumers are only willing to pay $4/gallon for 4 million gallons of oil but know they volition confront a $3/gallon tax at the till, they will merely purchase four million gallons if the ticket price is $1. This creates a new equilibrium where consumers pay a $2 ticket price, knowing they will have to pay a $iii tax for a total of $5. The producers will receive the $2 paid earlier taxes.
Note that whether the tax is levied on the consumer or producer, the final result is the same, proving the legal incidence of the tax is irrelevant.
Revenue enhancement – The Wedge Method
Another method to view taxes is through the wedge method. This method recognizes that who pays the revenue enhancement is ultimately irrelevant. Instead, the wedge method illustrates that a tax drives a wedge between the price consumers pay and the revenue producers receive, equal to the size of the taxation levied.
As illustrated below, to observe the new equilibrium, 1 but needs to find a $3 wedge between the curves. The first wedge tested is only $0.vii, followed past $ane.5, until the $3.0 tax is found.
Market Surplus
Like with price and quantity controls, one must compare the market surplus before and afterwards a toll change to fully sympathize the effects of a tax policy on surplus.
Before
The market surplus before the tax has non been shown, as the process should be routine. Ensure you lot understand how to become the following values:
Consumer Surplus= $4 million
Producer Surplus = $8 meg
Market Surplus = $12 meg
After
The market surplus after the policy can be calculated in reference to Figure 4.7d
Consumer Surplus (Blue Area) = $1 million
Producer Surplus (Red Area)= $two million
Authorities Revenue (Greenish Area) = $6 million
Market Surplus= $9 one thousand thousand
Why is Regime Included in Market Surplus
In our previous examples dealing with market surplus, nosotros did not include any give-and-take of government revenue, since the regime was non engaging in our market. Remember that market surplus is our metric for efficiency. If government was not included in this metric, it would not be very useful. In this case a million-dollar loss to regime would be considered efficient if information technology resulted in a $i proceeds to a consumer. To ensure that our metric for efficiency is yet useful we must consider regime when calculating marketplace surplus.
As with the quota – both consumer and producer surplus decreased because of a reduced quantity. The difference is, since the price is irresolute, there is redistribution. This fourth dimension, the redistribution is from consumers and producers to the government. Remember, simply a change in quantity causes a deadweight loss. Price changes just shift surplus around between consumers, producers, and the government.
Transfer and Deadweight Loss
Let's look closely at the tax'due south impact on quantity and price to see how these components affect the market place.
Transfer – The Bear on of Cost
Due to the tax's consequence on price, areas A and C are transferred from consumer and producer surplus to authorities acquirement.
Consumers to Government – Area A
Consumers originally paid $iv/gallon for gas. At present, they are paying $v/gallon. The $1 increase in price is the portion of the revenue enhancement that consumers take to bear. Despite the fact that the tax is levied on producers, the consumers have to bear a share of the price change. The size of this share depends on relative elasticity – a concept we will explore in the next department. This is because a decrease in price to producers ways quantity supplied is falling, and in order to maintain equilibrium, quantity demanded must fall by an equal amount. This price change means the government collects $1 10 ii million gallons or $2 meg in tax revenue from the consumers. This is a straight transfer from consumers to government and has no effect on market place surplus.
Producers to Government – Area C
Originally, producers received revenue of $4/gallon for gas. Now, they receive $2/gallon. This $2 subtract is the portion of the tax that producers take to bear. This means that the government collects $2 10 2 million gallons or $4 one thousand thousand in taxation acquirement from the producers. This is a transfer from producers to the government.
As calculated, the government receives a total of $6 million in tax revenue, which is taken from consumers and producers. This has no impact on net market place surplus.
Deadweight Loss – The Affect of Quantity
If we just considered a transfer of surplus, in that location would exist no deadweight loss. In this example, though, we know that price changes come with a change in quantity. A higher price for consumers will crusade a decrease in the quantity demanded, and a lower cost for producers will crusade a decrease in quantity supplied. This reduction from equilibrium quantity is what causes a deadweight loss in the market since there are consumers and producers who are no longer able to buy and supply the proficient.
Consumer Surplus Decrease – Area B
Due to the increase in price, many consumers will switch away from oil to culling options. This decrease in quantity demand of i.5 1000000 gallons of oil causes a deadweight loss of $one million.
Producer Surplus Decrease – Area D
Producers, who now receive only $two.00/gallon for their product, will as well decrease quantity supplied by 1.5 1000000 gallons of oil. It is no coincidence that the size of the decrease is the same. When you lot create the wedge between consumers and producers, you lot are finding the quantity where the full amount of the taxation is incurred but the market is still at equilibrium. Call up that quantity demanded must equal quantity supplied or the market volition not be stable. This mirrored decrease in quantity ensures this is all the same the example. Find, however, that the impact of this quantity drop causes a larger decrease in producer surplus than consumer surplus totalling $2 million. Again, this is due to elasticity, or the relative responsiveness to the price chance, which volition be explored in more detail shortly.
Together, these decreases crusade a $3 million deadweight loss (the difference between the market surplus earlier and marketplace surplus later).
Subsidy
While a revenue enhancement drives a wedge that increases the price consumers have to pay and decreases the cost producers receive, a subsidy does the opposite. Asubsidy is a benefit given by the government to groups or individuals, commonly in the form of a greenbacks payment or a taxation reduction. A subsidy is often given to remove some type of burden, and it is ofttimes considered to be in the overall involvement of the public. In economic terms, a subsidy drives a wedge, decreasing the cost consumers pay and increasing the price producers receive, with the government incurring an expense.
In Topic 3, nosotros looked at a case report of Victoria's competitive housing market where high demand drove upward prices. In response, the government has enacted many policies to allow depression-income families to yet go homeowners. Let's look at the effects of i possible policy. (Note the following policy is unrealistic merely allows for piece of cake comprehension of the effect of subsidies).
In the market in a higher place, our efficient equilibrium begins at a cost of $400,000 per home, with twoscore,000 homes existence purchased. The authorities wants to substantially increment the number of consumers able to buy homes, so information technology issues a $300,000 subsidy for any consumers purchasing a new home. This drives a wedge between what home buyers pay ($250,000) and what home builders receive ($550,000).
With all government policies we take examined so far, we have wanted to make up one's mind whether the upshot of the policy increases or decreases market surplus. With a subsidy, we want to exercise the aforementioned analysis. Unfortunately, because increases in surplus overlap on our diagram, it becomes more complicated. To simplify the assay, the following diagram separates the changes to producers, consumers, and government onto different graphs.
Producers
The producers now receive $550,000 instead of $400,000, increasing quantity supplied to 60,000 homes. This increases producer surplus byareas A and B.
Consumers
The consumers now pay $250,000 instead of $400,000, increasing quantity demanded to 60,000 homes. This increases consumer surplus pastareas C and D.
Government
The government now has to pay $300,000 per dwelling house to subsidize the threescore,000 consumers ownership new homes (this policy would cost the regime $xviii billion!!) Graphically, this is equal to a decrease in regime to areas A, B, C, D and E.
Result
Our total gains from the policy (to producers and consumers) are areasA, B, C and D,whereas total losses (the price to the regime) are areasA, B, C, D, and Due east.To summarize:
AreasA, B, C and D are transferred from the authorities to consumers and producers.
Area Due east is a deadweight loss from the policy.
In that location are ii things to notice nigh this example. Outset, the policy was successful at increasing quantity from forty,000 homes to 60,000 homes. 2nd, it resulted in a deadweight loss because equilibrium quantity was too high. Remember,anytime quantity is changed from the equilibrium quantity, in the absence of externalities, at that place is a deadweight loss. This is true for when quantity is decreased and when it is increased.
http://www.investopedia.com/terms/s/subsidy.asp
Summary
Taxes and subsidies are more complicated than a price or quantity control every bit they involve a third economical player: the regime. As we saw, who the tax or subsidy is levied on is irrelevant when looking at how the market place ends upwards. Annotation that the last 3 sections have painted a fairly grim picture show near policy instruments. This is because our model currently does non include the external costs economic players impose to the macro-environment (pollution, illness, etc.) or attribute whatsoever pregnant to equity. These concepts will be explored in more particular in later topics.
In our examples above, we run across that the legal incidence of the tax does not matter, but what does? To decide which political party bears more of the burden, we must apply the concept of relative elasticity to our analysis.
Glossary
- Economical Tax Incidence
- the distribution of tax based on who bears the burden in the new equilibrium, based on elasticity
- Legal Tax Incidence
- the legal distribution of who pays the tax
- Subsidy
- a benefit given by the government to groups or individuals, usually in the form of a cash payment or a taxation reduction It is often to remove some blazon of burden, and it is oftentimes considered to be in the overall involvement of the public
Exercises 4.seven
Refer to the supply and demand curves illustrated below for the post-obit THREE questions. Consider the introduction of a $20 per unit of measurement tax in this market.
1. Which areas represent the loss to consumer AND producer surplus as a effect of this tax?
a) k + f.
b) j + g.
c) k + j.
d) 1000 + f + j + grand.
ii.Which areas correspond the proceeds in government revenue as a event of this taxation?
a) one thousand + f.
b) j + g.
c) k + j.
d) thou + f + j + g.
3. Which areas represent the deadweight loss associated with this tax?
a) f + g.
b) k – one thousand.
c) j – f.
d) chiliad + f + j + thou.
4. Assume that the marginal price of producing socks is abiding for all sock producers, and is equal to $5 per pair. If government introduces a constant per-unit of measurement tax on socks, then which of the post-obit statements is FALSE, given the later-tax equilibrium in the sock market? (Assume a downwardly-sloping demand curve for socks.)
a) Consumers are worse off equally a result of the tax.
b) Spending on socks may either increase or subtract as a result of the tax.
c) Producers are worse off as a outcome of the tax.
d) This revenue enhancement will result in a deadweight loss.
5. Refer to the supply and demand diagram below.
If an subsidy of $3 per unit of measurement is introduced in this market, the cost that consumers pay will equal ____ and the price that producers receive cyberspace of the subsidy volition equal _____.
a) $two; $5.
b) $3; $vi.
c) $4; $vii.
d) $5; $8.
6. If a subsidy is introduced in a marketplace, and then which of the following statement is TRUE? Assume no externalities
a) Consumer and producer surplus increase but social surplus decreases.
b) Consumer and producer surplus decrease merely social surplus increases.
c) Consumer surplus, producer surplus, and social surplus all increment.
d) Consumer surplus, producer surplus, and social surplus all decrease
Utilize the diagram below to answer the following TWO questions.
7. If a $six per unit tax is introduced in this market place, then the price that consumers pay will equal ____ and the cost that producers receive net of the revenue enhancement will equal _____.
a) $x; $iv.
b) $9; $3.
c) $8; $2.
d) $7; $1.
8. If a $6 per unit revenue enhancement is introduced in this market, then the new equilibrium quantity volition be:
a) xx units.
b) 40 units.
c) 60 units.
d) None of the in a higher place.
9. Which of the following statements most the deadweight loss of taxation is True? (Assume no externalities.)
a) If at that place is a deadweight loss, then the revenue raised by the tax is greater than the losses to consumer and producers.
b) If at that place is no deadweight loss, and so acquirement raised by the government is exactly equal to the losses to consumers and producers.
c) Both a) and b).
d) Neither a) nor b).
10. Which of the post-obit correctly describes the equilibrium effects of a per-unit tax, in a market with NO externalities?
a) Consumer and producer surplus increase simply social surplus decreases.
b) Consumer and producer surplus subtract but social surplus increases.
c) Consumer surplus, producer surplus, and social surplus all increase.
d) Consumer surplus, producer surplus, and social surplus all decrease.
eleven. Which of the following correctly describes the equilibrium effects of a per unit subsidy?
a) Consumer price rises, producer price falls, and quantity increases.
b) Consumer toll falls, producer price falls, and quantity increases.
c) Consumer price rises, producer price rises, and quantity increases.
d) Consumer price falls, producer cost rises, and quantity increases.
12. Refer to the supply and need diagram below.
If an output (excise) revenue enhancement of $five per unit is introduced in this marketplace, the cost that consumers pay will equal ____ and the price that producers receive net of the tax will equal _____.
a) $v; $10.
b) $half dozen; $eleven.
c) $vii; $12.
d) $8; $3.
13. Consider the supply and demand diagram beneath.
If a $ii per unit of measurement subsidy is introduced, what will exist the equilibrium quantity?
a) forty units.
b) 45 units.
c) fifty units.
d) 55 units.
Consider the supply and demand diagram below. Assume that: (i) there are no externalities; and (2) in the absence of government regulation the market supply curve is the 1 labeled S1.
14. If a $5 per unit tax is introduced in this market, which area represents the deadweight loss?
a) a.
b) a + b.
c) b + c.
d) a + b + c.
Source: https://pressbooks.bccampus.ca/uvicecon103/chapter/4-6-taxes/
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