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SFC 2 Lecture 7 20th Oct 2021 Share
SFC 2 Lecture 7 20th Oct 2021 Share
Soumitra Ghosh
School of Health Systems Studies, Tata Institute of Social Sciences
The Costs or Economic Impact of Taxes
Taxes are the most important method by which governments fund their activities.
Analyse the effects of Taxes, how it affects welfare, economic wellbeing of people.
We will look at per unit taxes (taxes assessed as a particular amount in rupees on the sale of a good
or service, as opposed to a percentage tax. For example, the government imposes taxes amounting to
Rs. 7 per 200 ml can of carbonated drinks such as Coke and Pepsi (price is Rs. 25), as of 2021; GST
@28% plus 12%
The Impact of a Tax on Carbonated Beverages
Price
Without the tax, market equilibrium occurs at point (rupees S2
per can)
A.
S1
The equilibrium price of SSBs is 18.00 per can, and B
24
6 billion cans of soft drinks are sold per year.
0 5 6 Quantity of cans
(billions of cans per year)
The Impact of a Tax on Coke/Pepsi Cans
Price
The tax increases the price paid by consumers to 24 (rupees S2
per can)
per can.
Tax
revenue S1
Producers receive a price of 24 per can (point B
24
B), but after paying the 7 tax, they are left with 17
(point C).
18 A Deadweight loss
17 or excess burden
The government will receive tax revenue equal to C from tax
In the market for carbonated beverages, the buyers effectively paid 86% of the 7-rupees-per-
can GST, and sellers paid 14%.
This is known as the tax incidence: the actual distribution of the burden of a tax between
buyers and sellers in a market.
What determines this tax incidence? You would see that the answer is not “whoever is legally
obligated to pay the tax…”
What Does Determine the Tax Incidence?
The incidence of the tax is determined by the relative slopes of the demand and supply
curves.
A steep demand curve indicates that buyers hardly change how much they buy when price
changes; this results in them taking on much of the burden of the tax.
If the demand curve were flatter, buyers would change how much they purchased
considerably in response to a change in price. Then they could not be compelled to accept as
much of the burden of the tax.
Suppose, Ram cooks at Sarita’s house for Rs. 8,000/month. The opportunity cost of Ram’s
time is Rs. 6,000, and the value of homemade food to Sarita is Rs. 10,000.
Government imposes a tax of Rs. 4500 on the agency which supplies cooks
The tax has made both Sarita and Ram worse off by Rs. ?
What determines the Deadweight Loss?
Price
(rupees S2
per can)
S1
B
24
18 A
0 5 6 Quantity of cans
(billions of cans per year)
Things to remember to avoid common mistakes
Scarcity and shortage are not the same; both have technical meanings. There is no shortage of most
scarce goods.
Price ceilings are only effective if they are placed below the equilibrium price. Similarly, price floors are
effective only when above the equilibrium price.
When showing a tax, if sellers are legally obligated to pay the tax, move the supply curve up by the
amount of the tax; if buyers are obligated to pay the tax, move the demand curve down by the amount
of the tax.
The legal obligation to pay a tax is not the same as the tax burden.
To sum up
QD = 4,750,000 − 1,000P
5,750,000 = 2,300P
P = 5,750,000 / 2,300
= 2,500
Equilibrium
Find the equilibrium quantity of medicines sold:
QD = 4,750,000 – 1,000P
= 4,750,000 – 1,000(2,500)
= 2,250,000 or
QS = – 1,000,000 + 1,300P
= – 1,000,000 + 1,300(2,500)
= 2,250,000
We have found the equilibrium price and quantity; we can insert this on a demand and supply graph.
Contd..
To complete the diagram, let’s find the y-intercepts of the demand and supply curves, by setting QD
and QS equal to zero:
QD = 4,750,000 – 1,000P
0 = 4,750,000 – 1,000P
P = 4,750,000 / 1000
= 4,750
QS = –1,000,000 + 1,300P
0 = –1,000,000 + 1,300P
P = –1,000,000 / –1,300
= 769.23
The Efficiency of Competitive Equilibrium
Price Supply
Now we can calculate estimated
consumer and producer surplus, 4,750 Consumer
Surplus
using the triangle area formula:
Area = ½ (base)(height)
2500
CS = ½(2,250,000)(4,750 – 2,500)
QS = – 1,000,000 + 1,300P
= – 1,000,000 + 1,300(1,500)
3800
= 950,000
2500
Price Control
Find the price on the demand curve when the quantity of
medicines is 950,000: 1500
QD = 4,750,000 – 1,000P
P = –3,800,000 / –1,000 DD
0 950,000 2,250,000 Quantity
= 3,800
Price Ceiling:
Suppose the govt imposes a price ceiling of 1,500 per strip.
Calculate the quantity of medicines that will be sold:
Price SS
QS = – 1,000,000 + 1,300P
= – 1,000,000 + 1,300(1,500)
3800
= 950,000 B
2500
Price Control
Find the price on the demand curve when the quantity of C
A
medicines is 950,000: 1500
QD = 4,750,000 – 1,000P
D
950,000 = 4,750,000 – 1,000P
P = –3,800,000 / –1,000 DD
0 950,000 2,250,000 Quantity
= 3,800
Price Ceiling:
Now the diagram can guide our numerical estimates of
the economic effects of the rent controls.
Price SS
Producers lose area A (950 million) and area C (650 million); they originally had a
surplus of Rs. 1947.375 million, so now producer surplus is:
= 347.375 million