Taxes, trade, & welfare slide 1

Taxes and WelfareTaxes and WelfareIn 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.

Taxes, trade, & welfare slide 2

S

D

Q

P

Q*

P*

What are the welfare effects of an excise tax on beer?

BEER MARKET

Taxes, trade, & welfare slide 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

ba

c

S

Taxes, trade, & welfare slide 4

Economists call the loss in social welfare due to the tax

THE DEADWEIGHT LOSS

from the tax.

Taxes, trade, & welfare slide 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

Taxes, trade, & welfare slide 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.

Taxes, trade, & welfare slide 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

Taxes, trade, & welfare slide 10

Economists use terms such as "distortion of the market" to describe the loss.

The deadweight loss is an example of an economic inefficiency.

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The following hidden slide shows the effect of supply elasticity on the deadweight loss due to a tax.

Hidden slide

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

Hidden slide

Taxes, trade, & welfare slide 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.

Taxes, trade, & welfare slide 16

Trade and WelfareTrade and Welfare

In this section, we examine the effects on welfare of international trade.

The approach taken here, is to use the devices of Producer and Consumer Surplus.

The change in social welfare when trade is allowed can be measured by the changes in producer and consumer surplus.

Taxes, trade, & welfare slide 17

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P* = $10

The diagram below shows the U.S. domestic market for wine. No trade is

taking place.

WINE MARKET

Taxes, trade, & welfare slide 18

In the case of wine, let's suppose the world price is lower than the U.S no-trade price, say, $8.00 per bottle.

Taxes, trade, & welfare slide 19

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P

Q*

P* = $10

What happens with trade?

What are the welfare effects of trade?

WINE MARKET

P* = $8

Q"Q'

Taxes, trade, & welfare slide 20

S

D

Q

P

P* = $10

U.S. consumers gain b + d.

U.S. producers lose b.

Welfare rises by d.

WINE MARKET

P* = $8

Q"Q'

dc

b

a

The next (hidden) slide shows in a dynamic way who gains from trade when the world price is below the

domestic, no trade price.

Hidden slide

Taxes, trade, & welfare slide 23

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Q*

P* = $1500

The diagram below shows the U.S. domestic market for computers. No

trade is taking place.

COMPUTER MARKET

Taxes, trade, & welfare slide 24

Suppose computers can be sold for $2000 each on the world market and trade is allowed.

What happens with trade?

What are the welfare effects of trade?

Taxes, trade, & welfare slide 25

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D

Q

P

Q*

P* = $1500

U.S. consumers lose b.

U.S. producers gain b + d.

Welfare rises by d.

COMPUTER MARKET

P* = $2000a

b

c

d

The next (hidden) slide shows in a dynamic way who gains from trade when the world price is above the

domestic, no trade price.

Hidden slide

Taxes, trade, & welfare slide 28

Summary and conclusions

Allowing trade in a good will always increase social welfare (the sum of producer and consumer surplus).

When a good is exported, suppliers gain and consumers lose, compared to the no trade position.

When a good is imported, suppliers lose and consumers gain, compared to the no trade position.