Managerial Economics

Executive MBA Program

Session 6: Costs of Taxation
Instructor
Sandeep Basnyat
9841892281
Sandeep_basnyat@yahoo.co
m

 How

do taxes affect the

economic well-being of market
participants?

Tax Effect
Governments tax revenue = T Q; where
T = the size of the tax
Q = the quantity of the good sold

Price

Supply

CS

Price buyers
pay

Size of tax (T)

Tax
revenue
(T Q)
Price sellers
receive

??

PS

Demand

Quantity
sold (Q)
0

Quantity
with tax

Quantity
without tax

Quantity

How a Tax Effects Welfare?: Deadweight Loss !

Price

Price
buyers = PB
pay

Supply

Price
without tax = P1
Price
sellers = PS
receive

A deadweight loss is the

fall in total surplus that
results from a market
distortion, such as a tax.

D
F

Demand

Q2

Q1

Quantity

Is there any relationship

between Elasticity and
Deadweight Loss?

Tax Distortions and Elasticities

(a) Inelastic Supply

Price
Supply

When supply is
relatively inelastic,
the deadweight loss
of a tax is small.
Size of tax

Demand
0

Quantity

Tax Distortions and Elasticities

(b) Elastic Supply

Price
When supply is relatively
elastic, the deadweight
loss of a tax is large.
Size
of
tax

Supply

Demand
0

Quantity

Tax Distortions and Elasticities

(c) Inelastic Demand
Price
Supply

Size of tax
When demand is
relatively inelastic,
the deadweight loss
of a tax is small.

Demand
0

Quantity

Tax Distortions and Elasticities

(d) Elastic Demand
Price

Supply

Size
of
tax

Demand
When demand is relatively
elastic, the deadweight
loss of a tax is large.

Quantity

DETERMINANTS OF THE
DEADWEIGHT LOSS

The greater the elasticities of demand

and supply:
the larger will be the decline in
equilibrium quantity and,
the greater the deadweight loss of a tax.
Policy makers should be careful before
imposing Taxes on Products !!

Is there any relationship

between DEADWEIGHT
LOSS and TAX REVENUE as
Taxes very?

Small Tax

Medium Tax

Revenue
and Tax Size

Large Tax

Tax Revenue

Deadweight
Loss

How Deadweight Loss and Tax Revenue Vary with the Size
of a Tax
(a) Deadweight Loss
Deadweight
Loss

Tax Size

How Deadweight Loss and Tax Revenue Vary with the Size
of a Tax
(b) Revenue (the Laffer curve)
Tax
Revenue

Tax Size

Numerical Problems
Consider the previous market with Demand curve q = 16 10p and
Supply curve q = 8 + 20p. (Here q is in millions of kg. and p is in
dollars per kg.). Imagine that the government imposes a $0.60 per-unit
tax on the prices that buyers pay. Calculate the deadweight loss due to
imposition of tax in this market.

Numerical Problems
Consider the previous market with Demand curve q = 16 10p and
Supply curve q = 8 + 20p. (Here q is in millions of kg. and p is in
dollars per kg.). Imagine that the government imposes a $0.60 per-unit
tax on the prices that buyers pay.
Deadweight loss= $1.2 million

Thank you