Taxes and Welfare

In this section, we examine the effects on welfare of

changes in excise taxes.
The approach taken here, is to use the devices of
Producer and Consumer Surplus.
The social welfare from the production and
consumption of a particular amount of a good is
the sum of the producer surplus, consumer
surplus, and any tax revenue taken in by the
government.

Taxes and welfare slide 1

 What are the welfare effects of an
excise tax on beer?
P
S

P*

D
Q* Q
BEER MARKET
Taxes and welfare slide 2
 CHANGE IN CS = -a - b
CHANGE IN PS = -c - d
TAX REVENUE OF GOV'T = a + c
So social cost = b + d S+t
P TAX
PER
UNIT S

a b
P*
c d

D
Q* Q
BEER MARKET
Taxes and welfare slide 3
Economists call the loss in social welfare due to the
tax

THE DEADWEIGHT LOSS

from the tax.

Taxes and welfare slide 4

 Illustrating the deadweight loss
The following hidden slide shows the changes in
surplus and the deadweight loss due to an excise
tax.

Hidden slide

Taxes and welfare slide 5

The size of the deadweight loss is determined by

1) The elasticity of the demand curve.

2) The elasticity of the supply curve.

3) The amount of the tax per unit.

Taxes and welfare slide 7

The following hidden slide shows the effect of
demand elasticity on the size of the deadweight
loss in welfare due to an excise tax.

Hidden slide

Taxes and welfare slide 8

Economists use terms such as "distortion of the
market" to describe the loss.

The deadweight loss is an example of an economic

inefficiency.

Taxes and welfare slide 10

 The following hidden slide shows the effect of
supply elasticity on the deadweight loss due to a tax.

Hidden slide

Taxes and welfare slide 11

 The following hidden slide shows the effect of
demand elasticity on the government’s tax revenue.

Hidden slide
Notice that this analysis can also be applied to
subsidies:

A per unit subsidy will create a DEADWEIGHT

LOSS in social welfare. In the case of the subsidy
too much of society's resources will be devoted to
the good.

Taxes and welfare slide 15