Incidence of a tax
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Incidence of a tax
The Incidence of a sales tax
• The incidence of a sales tax describes who actually bears the burden of the tax. – What portion of the tax does the producer pay?– What portion of the tax does the consumer pay?
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
Indirect taxes increase costs and shift the supply curve to the left
S+tax
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
Consumers pay the new equilibrium price - Pc
S+tax
Pc
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
The per unit tax is measured by the vertical distance between the two supply curves
S+tax
Q’
Pc
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
The producer recieves the lower price - Pp
S+tax
Q’
Pc
Pp
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
The government receives the shaded area as tax revenue
S+tax
Q’
Pc
Pp
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
Original CS
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
New CS
The area of tax which was previously CS
represents the incidence of the tax on
consumers
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
Original PS
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
New PS
The area of tax which was previously PS
represents the incidence of the tax on
producers
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
DWL
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
Original PS
What area represents the incidence of the tax on producers?
The area of producer surplus they have lost and is now tax revenue to the government.
An Indirect Tax
Price
Quantity
S
D
Pm
Qm
S+tax
Q’
Pc
Pp
Original CS
What area represents the incidence of the tax on consumers?
The area of consumer surplus they have lost and is now tax revenue to the government.
The incidence of indirect taxes: depends on different demand elasticity's
Quantity
Price
D
Relatively Inelastic Demand
SSt
Q1 Q
P1
P
Incidence on
Consumers
Incidence on Producers
Quantity
Price
D
Relatively Elastic Demand
S
St
Q
P
Q1
P1
Incidence on Producers
Incidence on Consumers
When a sales tax is imposed on a good with relatively inelastic demand, the government is able to raise a large amount of tax revenue, suppliers will not suffer a large drop in sales and the incidence of the tax falls more heavily on the consumer
When a sales tax is imposed on a good with a relatively elastic demand, the quantity demanded is more responsive to a change in price. The government is not able to raise as much tax revenue, and suppliers will suffer a large drop in sales, however the incidence will fall more heavily on the producer.
Excise Tax
• Excise taxes will raise the most revenue and result in the least DWL when the price elasticity of demand for the commodity is low.
An excise tax is a tax on the sale of a commodity such as cigarettes, petrol or alcohol.
The Incidence of Subsidies • With a subsidy on consumer goods and
services as medicine or public transport, the benefits will flow on to the consumer in the form of lower prices.
– Who will benefit the most?– By how much?– How is this affected by differing levels of PED
The incidence of Subsidies - Copy
• The incidence of subsidy shows the extent to which consumers or producers will gain from the subsidy.
A Subsidy
Price
Quantity
S
D
Pm
Qm
A Subsidy
Price
Quantity
S
D
Pm
Qm
Subsidies reduce costs and increase Supply
S+Subsidy
A Subsidy
Price
Quantity
S
D
Pm
Qm
Consumers pay the new equilibrium price - Pc
S+Subsidy
Q’
Pc
A Subsidy
Price
Quantity
S
D
Pm
Qm
The per unit subsidy is represented by the vertical distance between the two supply curves
S+Subsidy
Q’
Pc
A Subsidy
Price
Quantity
S
D
Pm
Qm
Producers receive higher price -Pp
S+Subsidy
Q’
Pc
Pp
A Subsidy
Price
Quantity
S
D
Pm
Qm
The total cost to the government is represented by the shaded area
S+Subsidy
Q’
Pc
Pp
A Subsidy
Price
Quantity
S
D
Pm
Qm
S+Subsidy
Q’
Pc
Pp Original CS
A Subsidy
Price
Quantity
S
D
Pm
Qm
S+Subsidy
Q’
Pc
Pp New CS
The gain in CS represents the incidence of a
subsidy on consumers
A Subsidy
Price
Quantity
S
D
Pm
Qm
S+Subsidy
Q’
Pc
Pp Old PS
A Subsidy
Price
Quantity
S
D
Pm
Qm
S+Subsidy
Q’
Pc
Pp New PS
The gain in PS represents the incidence of a
subsidy on producers
A Subsidy
Price
Quantity
S
D
Pm
Qm
S+Subsidy
Q’
Pc
Pp DWL
The incidence of subsidies
The incidence of subsidies:effects of different demand
elasticities
fig
S + subsidy
S
O
P2 +S
P1
P2
Q2Q1
D
Incidence of a subsidy: elastic demandP
Q
Consumers share
Producers
share
Who receives the subsidy?• When the price elasticity of a good is
elastic, the producers end up receiving most of the subsidy.
fig
Incidence of a subsidy: inelastic demand
S + subsidyS
O
P1
P2
Q2Q1
D
P
Q
P2 + S
Consumers
Share
Producers share
Who receives the subsidy?• When price elasticity of demand is
Inelastic, the consumers will receive most of the subsidy.
• This occurs for goods that are a necessity (hence an inelastic demand curve).
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