Principles of Microeconomics / Unit 4 MIC 0330 review, 2 to 3 minutes
One Excise Tax, Fully Worked
The idea
A single excise tax exercises every idea in this unit, and working it twice, with the elasticities reversed, shows what elasticity decides. Start with the market before the tax: an equilibrium price and quantity, buyers' surplus above the price, sellers' surplus below it. Insert the wedge. The quantity falls to where the buyer price and the seller price differ by exactly the tax. Now read four things. Incidence: the buyer price minus the old price is buyers' share; the old price minus the seller price is sellers' share; the larger share falls on the more inelastic side. Revenue: the tax times the new quantity, a rectangle that was surplus and is now the government's. Deadweight loss: one half of the tax times the lost quantity, a triangle that was surplus and is now nobody's. Remaining surplus: what buyers and sellers keep above and below the new prices. Then reverse the elasticities. Make demand elastic and supply inelastic, and the same tax shifts most of the burden to sellers, cuts quantity by more, raises less revenue, and destroys more surplus. Every one of those changes follows from one fact: the more elastic side escapes, and the more both sides can escape, the smaller the base and the larger the loss.
In practice
Worked example, the juice market twice. Inelastic demand: twelve thousand bottles at three dollars; after a one-dollar tax, nine thousand bottles, buyers pay three seventy and sellers keep two seventy. Buyers bear seventy cents, sellers thirty; revenue nine thousand dollars; deadweight loss fifteen hundred. Now elastic demand and inelastic supply, same starting point: after the same tax, seven thousand bottles, buyers pay three twenty-five and sellers keep two twenty-five. Buyers bear twenty-five cents, sellers seventy-five; revenue seven thousand dollars; deadweight loss one half times one dollar times five thousand, two thousand five hundred. Same tax, same market before, and the second version raises two thousand dollars less while destroying a thousand dollars more.
Where people slip
Three cautions. Incidence is about elasticity, never about who remits the tax; the register price misleads. Revenue and deadweight loss move opposite ways as elasticity rises, which is why a revenue tax wants inelastic goods and a corrective tax wants elastic ones. And the triangle's base is the lost quantity, the change, not the quantity that remains; the most common error in this unit is to compute the loss on the wrong base. Unit eleven returns to the wedge as a remedy rather than a cost, when the tax corrects a pollution externality.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
Builds on
Unlocks
- Nothing yet depends on this.
Something wrong in this lesson? Flag it