TAILIEUCHUNG - Ten Principles of Economics - Part 17

Ten Principles of Economics - Part 17. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 8 APPLICATION THE COSTS OF TAXATION 167 Figure 8-5 Tax Distortions and Elasticities. In panels a and b the demand curve and the size of the tax are the same but the price elasticity of supply is different. Notice that the more elastic the supply curve the larger the deadweight loss of the tax. In panels c and d the supply curve and the size of the tax are the same but the price elasticity of demand is different. Notice that the more elastic the demand curve the larger the deadweight loss of the tax. Let s consider first how the elasticity of supply affects the size of the deadweight loss. In the top two panels of Figure 8-5 the demand curve and the size of the tax are the same. The only difference in these figures is the elasticity of the supply curve. In panel a the supply curve is relatively inelastic Quantity supplied responds only slightly to changes in the price. In panel b the supply curve is 168 PART THREE SUPPLY AND DEMAND II MARKETS AND WELFARE relatively elastic Quantity supplied responds substantially to changes in the price. Notice that the deadweight loss the area of the triangle between the supply and demand curves is larger when the supply curve is more elastic. Similarly the bottom two panels of Figure 8-5 show how the elasticity of demand affects the size of the deadweight loss. Here the supply curve and the size of the tax are held constant. In panel c the demand curve is relatively inelastic and the deadweight loss is small. In panel d the demand curve is more elastic and the deadweight loss from the tax is larger. The lesson from this figure is easy to explain. A tax has a deadweight loss because it induces buyers and sellers to change their behavior. The tax raises the price paid by buyers so they consume less. At the same time the tax lowers the price received by sellers so they produce less. Because of these changes in behavior the size of the market shrinks below the optimum. The elasticities of supply and demand measure how much .

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