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# Taxation and dead weight loss

When a tax is imposed in a market this is another example of government intervention. In this video, we explore the effect of imposing a tax on the price and quantity in a market. Created by Sal Khan.

## Want to join the conversation?

• I don't see why the added sales tax would shift the supply curve. I would expect it to shift the demand curve to the left. It is not a cost that the producer has to bear. The consumer is now paying \$4.75 for what previously cost \$3.75. The producer will continue to receive the same \$3.75.
• Timothy Stanton is right, you can achieve the same result by shifting the demand curve. However, it is more intuitive to add a "supply + tax curve", let me explain: If burgers are \$5 a unit, and a \$1 tax is added, the total per unit burger price will rise to say \$5.50 (not to \$6, remember producers and consumers share the burden of taxes). From a consumer's perspective, it does not matter if \$5 goes towards producers and \$.50 goes towards tax, or if the whole \$5.50 goes towards producers. It is still a total cost of \$5.50 for a hamburger. So whether the price rose because of tax or simply the producer's decision, it is nothing more than a price increase to the consumer. And as the law of demand states, an increase in price decreases QUANTITY demanded, not demand. So the quantity demanded should decrease (which it did) yet the demand curve remains stable. Also notice the new line is not a shift in the supply curve. It is a whole new equation represented as "supply plus the excise tax". You may even notice Sal called the new line the supply "from the consumer's perspective". The actual supply curve doesn't shift, suppliers are still producing at the original line (notice how producer surplus extends all the way to the original line, even after tax). In summary, an excise tax doesn't shift demand or supply, the curves remain stable, the market is not pareto optimal, and the excess burden of taxation (deadweight loss) takes its effect.
• how can you figure out the value of the dead weight loss in numbers??
• If supply and demand are linear, you calculate them as the area of a triangle: 1/2 x base x height.
• Why is the governments revenue not the area between the new supply curve and the old supply curve (the 1\$ area difference?
• It would be, only the demand for Hamburgers falls when the cost increases.
• What does tax burden mean?
• When a tax is implemented, it will impact producers and consumers in certain ways depending on the elasticity of demand. Specifically, the tax burden falls on the group (producers or consumers) who bear most or all of the tax.

Take a case where demand is very elastic relative to supply. That means that when price changes, quantity demanded will change a lot and quantity supplied will change very little. If a tax is implemented, you will see that the tax burden falls on the firm in this case, as consumers react a lot to the change in price. Put another way, the change in quantity (caused by the change in price) hit the firm harder than it hit consumers.

It's hard to show without an ability to draw, but you can see this site for more info. http://www.bized.co.uk/virtual/economy/policy/tools/vat/vatth3.htm
• Doesn't the government spending tax dollars actually offset the 'dead weight' of taxes? Some argue that the benefit actually exceeds this loss. Is this true?
• You can't "offset" a deadweight loss. It's irrelevant where the money goes later - the model's deadweight is never going away. However, the loss could be worth it if the tax revenue is spent wisely. For example, some legal framework to enforce property rights via police and courts is necessary for the free-market capitalism in these models to exist at all.
• At Sal says the Producer Surplus is shrunken? But is it really?
Yes the price point (before tax) is reduced from 3.75 to 3 due to the 'Consumer' shift in Supply Curve. But the producer surplus is the same area as if one were to sell the burgers at \$3 each before tax comes into play.
Is it really correct to say Producer Surplus decreases? I need some clarification :\$
• Yes, producer surplus really has decreased. You're right that it's the same producer surplus as if they sold the burgers for \$3, but they're not selling them for \$3. And even if they did, they wouldn't be for long, because there would be excess demand that would drive the equilibrium quantity up.

It is important to note that the price point has not been reduced from \$3.75 to \$3. The amount the seller receives has dropped from \$3.75 to \$3 as a result of the tax.

Most of the producer surplus has been lost to the government (through the tax), while the remainder is deadweight loss (which is the amount that is lost due to decreased quantity—as a result of the tax driving up the price—which is not recouped by the tax).
• How do I calculate subsidy?
• In a more realistic scenario would we also see the demand curve shift as a result of the increased supply price?
• I think you are missing the point of the demand curve. The curve represents the willingness of a consumer to purchase as the price gets cheaper. In this case, the supply curve shifts up because of the tax.
• Why doesn't the demand curve shift with a tax?
(1 vote)
• It does shift left, from the producer's point of view. From the consumer's point of view, their own preferences haven't changed but supply instead has shifted left.
• It seems as if an increase in taxation will lead to an increase in deadweight loss. Are there any ways the same tax revenue can be raised but without any deadweight loss?
• I don't think so, but the tax may serve to re inject that money to the economy (in the form of welfare programs, retirement, social security, creation of jobs, etc) so that more people may have the money to buy the taxed hamburgers thus filling the dead weight loss.
(1 vote)