CHAPTER 8 – APPLICATION: THE COST OF TAXATION

As we used to learn about tax in chapter 6, we can know that:

- The ultimate ( cơ bản, nền tảng ) impact of a tax in the market outcome is the same whether
the tax is levied on buyers or sellers of a goods.
- A tax levied on buyers shifts the demand surve downward by the size of the tax; a tax levied on
sellers shifts the supply curve upward by that amount.
- In either case, the tax raises the price paid by buyers and reduces the price received by sellers.
As a result, how the tax burden is distributed between producers and consumers depends not on
how the tax is levied but on the elasticities of supply and demand.
- Moreover, a tax on a good make the size of the market for the good smaller.
Looking at the figure 1

How a tax effects market participants.

- To measures the gains and losses from a tax from a good, we use the tools of welfare economics
=> đánh giá xem ai là người có lợi, ai là người thiệt khi có một loại thuế mới.
+ the benefit received by buyers in a market is measured by customer surplus = the amount
buyers are willing to pay for the good – the amount they actually pay for it.
+ The benefit received by sellers in a market is measured by producer surplus = the amount
sellers receive for the good – their cost of producing it.
+ The government ?
If T iss the size of the tax, Q is the quantity of the good sold
 The total tax revenue is T x Q

This tax revenue is used for government services => so the benefit actually accrues (đổ dồn vào)
not to the government but to those on whom the revenue is spent.

Looking at the figure 2, we can see that the government tax revenue is presented by the
rectangle between the supply and demand curves. The height of this rectangle is the size of the
tax T, and the width of rectangle is the quantity of the good sold Q. Because a rectangle’s area is
its height mintiplied its width, this rectangle’s area is TxQ, which equal the tax revenue.

Let’s talk about the welfare without a tax.

- Looking at the figure 3, without tax, the equilibrium price and quantity are found at the
intersection (giao diem) of the supply and demand curve, P1 and Q1
- Becaue the demand curve reflect people’s willing to pay => consumer surplus is the area
between the demand curve and price => SC=A+B+C
- Simillarly, because the supply curve reflects sellers’ costs, producer surplus is the area between
the supply curve and the price => PS= D+E+F
- In this case, no tax => tax revenue is 0
 Total surplus ( is the area between supply and demand curve up to equilibrium quantity, Q1)
=A+B+C+D+E+F
 Ok, now Let’s talk about the welfare with a tax.

When having tax, the price that people have to pay rises from P1 to Pb.

 We can see that the the consumer surplus is the area below the demand curve and above
the buyer’s price Pb => so the consumer surplus now equal A
- When having tax, the price received by sellers falls from P1 to Ps
 So the producer surplus ( the area above the supply curve and below seller’s price Ps) now
equal F.
- The quantity sold falls from Q1 to Q2 => the government collects tax revenue equal area B+D.
- The total surplus with the tax is computed by add consumer surplus, producer surplus and tax
revenue. => Total surplus is A+B+D+F
CHANGES:
- CS falls by the area B+C
- PS falls by the area D+E
- The tax revenue rise by the area B+D.
-
- total surplus in the market falls by area C+E. => The losses to buyers and sellers from a tax
exceed the revenue raised by government
- The fall in total surplus that results when a tax distorts (làm méo, biến dạng) a market outcome
is called a deadweight loss. The area C+E measures the size of the deadweight loss.
-
- As we used to study in Chapter 1, there have a principal that: People respond to incentives. And
in chapter 7 we saw that free markets normally allocate scarce resources efficiently. So, it means
that without tax, the equilibrium of supply and demand maximizes the total surplus of buyers
and sellers in the market
- When the government impose the tax, it raises the price buyers pay and lowers price seller
receive => giving buyers an incentive to consume less and sellers incentive to produce less.
- As a results, the size of the market shrinks below its optimum ( đkien thuận lợi nhất)
- => Becase taxes distort incentives, they cause markets to allocate resources inefficiently.

DEADWEIGHT LOSSES AND THE GAINS FROM TRADE

- To understand why tax cause deadweight, I have an example:

- Ben clean Mai’s house each week for 100$
+ the opportunity cost of Ben is 80$
+ The value of clean house to Mai is 120$
 Both of them receive 20$ benefit => Total surplus is 40$

But when the government impose tax on cleaning service is 50$

- If Mai only willing to pay 120$ => Ben can receive 70$ after paying for the tax ( less than the
opportunity cost 80$)
- Or if Ben cover his opportunity cost is 80$, Mai would need to pay 130$, which is above 120$
value she places on clean house
- => As a results, they cancel their arrangement. Ben loses the income and Mai live in the dirty
house.
 - In this case. Although the tax has made both of them each lost 20$. But governemt collect no
revenue from Ben and Mai because they cancel their arrangement.
- From this example we can see that: Taxes cause deadweight losses because they prevent buyers
and sellers from realizing some of the gains from trade.

Looking at the figure 4, when the tax rises the price buyers pay to Pb and lowers the price sellers receive
to Ps => the marginal buyer and sellers leave market => the quantity seld falls from Q1 to Q2. In this
figure we can see that the value of the good to these buyers still exceeds the cost to these sellers.

- At every quantity between Q1 and Q2, the situation is the same as in our example we
mentioned before
- => The gains from trade:
+ The difference between buyers’s value and sellers’ cost are less than the tax => leading to the
trades are made because of the tax is imposed

DEADWEIGHT LOSS AND TAX REVENUE AS TAXES VARY

Deadweight loss
- When we increase the tax, the deadweight loss increases ( even more rapid than the size of the
tax)
- Because the deadweight loss is the area of a triangle, and the area depends on the square of its
size.
- For EX, if we double the size of tax, the base and height of the triangle is double
- , so the deadweight loss by a factor of four.
Tax revenue
- The tax revenue equal the area of the rectangle between supply and demand curve. Looking at
the figure 6 we can see that, (a) the revenue tax is small, when increase in tax (b), the tax
revenue is bigger, but when the tax continue increase (c), the tax revenue falls. Because the
higher tax drastically reduces the size of the market. For a very large tax, no revenue would
raised because people would stop buying and selling the good together.
- The last two panels, in (d) we can see that when the size of a tax increase, its deadweight loss
quickly get larger. By contrast, panel € shows that tax revenue first rises with the size of tax but
as the tax increase further, the market shrinks too much that the tax revenue starts to falls.