Lecture 9: Introduction to Taxation

Econ S-1814
Danny Shoag

Outline
Warning!! Boring but important!
Demand & Supply Curves:
Aggregation
Consumer + Producer Surplus
Elasticity

Taxes
Deadweight loss
Incidence

More interesting
Examples

Taxation
(drawing heavily from Chetty lectures)
Who pays a tax? Who gets a subsidy?
Tobacco tax, EITC, food stamps, etc

Key Idea:

Statutory Incidence Economic Incidence

Reminder about Demand Curves

Price

Number of people willing to

pay that price
50
45
40
25
20
10

20
22
25
40
50
100

Demand Curve
250

Price

200
150
100
50
0

10

20

30
Quantity

40

50

60

Demand Curves
Demand Curve
250

200

Price

150

100

50

10

20

30
Quantity

40

50

60

Calculating Consumer Surplus

Price

50

People

20

45

22

40

25

25

40

Reason

Formula

20 people willing to pay $50

Only have to pay $30

20*($50-$30)

2 more people
willing to pay $45

2*($45-$30)

3 people willing to pay $40

3*($40-$30)

15 people willing to pay $30

15*($30-35)

Surplus

$400

Total

$30
$30
0
$460

Graphing Consumer Surplus

Price Elasticity
What does it mean?

Price Elasticity
What does it mean?

Price Elasticity
What does it mean?

A percent in demand/supply for a one percent change in price

Unit free!

Elasticity
That formula can be rewritten:

The numerator is the slope of the demand/supply curve with

respect to price

Calculating a Demand Elasticity

Price

Quantity
Demanded

Percent
Change in
Price

50

20

45

22

40

25

25

40

20

50

10

100

Percent
Change in Q

Demand Curve
250

Price

200
150
100
50
0

10

20

30
Quantity

40

50

60

Calculating a Demand Elasticity

Price

Quantity
Demanded

Percent
Change in
Price *

Percent
Change in Q

50

20

45

22

-10%

10%

40

25

-12%

12%

25

40

-46%

46%

20

50

-25%

25%

10

100

-100%

100%

Demand Curve
250

Price

200
150
100
50
0

10

20

30
Quantity

40

50

60

Calculating a Demand Elasticity

Price

Quantity
Demanded
50
45
40
25
20
10

Percent
Change in
Price *
20
22
25
40
50
100

-10%
-12%
-46%
-25%
-100%

Percent
Change in Q

10%
12%
46%
25%
100%

The elasticity here is -1. When the price goes down by 1% , the
quantity demanded goes up by 1%.

Here the elasticity is constant (doesnt depend on where you are on

the curve). That doesnt have to be true!!

Supply
Supply Curve
Price

90

Quantity
Supplied

80
70

50

80

40

64

30

48

10

16

Price

60
50
40
30
20
10
0

10

20

30
Quantity

40

50

60

Supply
Demand & Supply Curves
250

200

Price

150

100

50

10

20

30
Quantity

40

50

60

Equilibrium
Equilibrium
250

200

Price

150

100

50

10

20

30
Quantity

40

50

60

Producer Surplus

Total Surplus

What does a tax do?

Excise tax per unit. Ad valorem fraction of the price.

What does a tax do?

What does a tax do?

What does a tax do?

Levied on the demand side

Levied on the demand side

$7.5

Levying on the demand side

Why is this true?

Post tax equilibrium with supplier taxes is given by

We can take the total differential:

This is the change in the price actually paid by consumers

Why is this true?

Post tax equilibrium with supplier taxes is given by

We can take the total differential:

Multiply
all terms
By P/Q

This is the change in the price actually paid by consumers

Why is this true?

Post tax equilibrium with supplier taxes is given by

We can take the total differential:

How do we know its positive?

Why is this true?

Post tax equilibrium with supplier taxes is given by

We can take the total differential:

This is the change in the price actually paid by consumers

Why is this true?

Suppose we now put the tax on the consumer side

Price paid by consumers is p+ t

Why is this true?

Suppose we now put the tax on the consumer side

Multiply
all terms
By P/Q
again

Price paid by consumers is p+ t

Why is this true?

Suppose we now put the tax on the consumer side

This is
equal to 1
I just
replaced it

Price paid by consumers is p+ t

Why is this true?

Suppose we now put the tax on the consumer side

Same as
before!

Price paid by consumers is p+ t

Perfectly Inelastic

Perfectly Elastic

Deadweight Loss
DWL = Q t

Deadweight Loss
DWL = Q t

Deadweight Loss
DWL = Q t

Deadweight Loss
DWL = Q t

Deadweight Loss
DWL = Q t

Deadweight Loss
DWL = Q t

Deadweight Loss
* Grows with the square of the
tax rate
*Increases with the elasticities
* Increases with the budget share

Examples finally!
State tobacco taxes whats your prior?

Examples finally!
Evans, Ringel, & Stech: pass-through estimates ~100%
Demand elasticity is about -.42

What does that imply about supply-elasticity?

What does this tell us about the market?
Who bears pays the tax?

Interesting fewer cig purchases

same cotinine in lungs
--Elasticity!

Hastings & Washington

NV gave food stamps at the first of the month
Grocery expenditure for benefit households is 20-30%

higher in the first week

Stores in poor neighborhoods raise prices 3% that week
What does this tell us about that market?

Hastings & Washington

Who benefits from this policy?

Other Examples
EITC and low-wages workers (Rothstein)

Employers can lower wages and people will still work

Finds EITC workers gain $.70 per $1, employers gain $.70,
ineligible low-skilled workers loss $.4

Medicare part D (Friedman)

Capitalization in to asset prices

Drug companies captured about 1/3 of the surplus

Last Example (Linden & Rockoff)

Linden & Rockoff

Housing Prices fall 4% -- huge implied cost!

Thought Experiment
Suppose your state wanted to enhance maternity benefits.

What will determine who benefits?

Think about for next time

How do these forces differ at local and national levels?

Local market power vs. national market power

Ability for workers and capital to move

Salience and evasion opportunities