Taxes and Subsidies

1. Taxes and Subsidies

2. Overview This presentation will demonstrate how to show changes in surplus when taxes and subsidies are imposed.

3. Tax • Here is an economy before a tax S PNoTax D Q*

4. Tax • Suppose a $1 tax is implemented • The price of supply must now be $1 less than the price of demand • The height of the solid red line is the amount of the tax • To make S = D, we need different prices for buyers and sellers S Pτd PNoTax Pτs D Qτ Q*

5. Tax • We can now break the graph into regions and use them to label CS and PS, before and after the tax • Always choose regions so that each region is either a triangle or a rectangle, so we can easily compute surpluses when numbers are available A S Pτd B C PNoTax E D Pτs F D Qτ Q*

6. Tax • Lastly, make a table to clearly indicate what each region was, with and without the tax A S Pτd B C PNoTax E D Pτs F D Qτ Q*

7. Subsidy • Now, suppose a $1 subsidy is implemented • The price of supply must now be $1 more than the price of demand • The height of the solid red line is the amount of the subsidy S Pτs PNoTax Pτd D Qsub Q*

8. Subsidy • Break the graph into regions as before • There will be overlap in assigning regions to surplus categories, but don’t worry about that here A S Pτd G B C I PNoTax E D H Pτs F D Qsub Q*

9. Subsidy • Now assign the regions to surpluses • With a subsidy, certain regions will go to more than one category • Remember that GS is negative here A S Pτs G B C I PNoTax E D H Pτd F D Qsub Q*