Taxes & Subsidies
A tax of 6 per unit: do buyers pay it, or sellers? Usually both, in proportions set by the slopes of the curves. See the new prices, the tax revenue, and the trade that no longer happens — or what a subsidy costs.
Who Really Pays a Tax?
A tax raises the price buyers pay and lowers the price sellers keep; the difference is the tax. How it is split — the tax incidence — depends only on how strongly each side reacts to the price. The side that cannot easily walk away, the less elastic one, carries more of the burden.
Because the price goes up, some trades that would have been worth it no longer happen. The value they would have created is simply lost: the deadweight loss, the triangle in the chart. A subsidy creates the opposite situation, but costs the government more than buyers and sellers gain.
The Tax Wedge
taxBigger Taxes
your curves| Tax per unit | Quantity | Revenue | Deadweight loss |
|---|
Worked Techniques
Demand at the buyers’ price must equal supply at the sellers’ price.
The tax per unit times the units still traded. Raise the tax far enough and revenue falls again, because trade dries up.
The triangle between the curves for the units that are no longer traded. Doubling the tax makes it four times as large.
Sources & Verification
- N. G. Mankiw, Principles of Economics, 9th ed., Cengage, 2021 — Ch. 6 (Supply, Demand, and Government Policies) and Ch. 8 (Application: The Costs of Taxation).