IB Economics HL Topics

1. IB Economics HL Topics Indirect Taxes, Subsidies and Price Controls

2. Tax Incidence (burden) • Is a measure of the consequences of a tax on all the affected parties • Tax impacts the profitability of any product, the degree may vary • Whoever pays the tax suffers the tax burden

3. Tax incidence: PED similar to PES Price S + tax S Ptax Tax Revenue Tax burden of consumer Pe Tax burden of producer P1 D Quantity Qtax Qe

4. PED similar to PES • Consumers and producers share the burden of tax equally • Consumers pay more and receive less output • Consumer and producer surplus decreased • Market size was reduced from Qe to Qtax

5. Tax incidence: PED > PES Price S + tax S Ptax Tax Revenue Tax burden of consumer Pe Tax burden of producer P1 D Quantity Qtax Qe

6. PED > PES • Demand is more elastic than supply • Consumers are more responsive to price, and therefore less tolerant of price increases • Producers pay more of the burden of the tax • Government receives less revenue • Market size decreases quite significantly, therefore employment is more likely to decline • Deadweight loss is greater due to large decrease in quantity

7. Tax incidence: PED < PES Price S + tax S Ptax Tax Revenue Tax burden of consumer Pe producer P1 D Quantity Qtax Qe

8. PED < PES • Consumers are relatively indifferent to price changes • Consumers tax burden is greater than producers • Government receives more revenue • Market size decreases relatively little, therefore employment is less affected • Deadweight loss is smaller

9. PED vs PES Summary • The more elastic the demand relative to supply, the greater the burden paid by producers, the greater the deadweight loss, and the smaller the government revenue • The more inelastic the demand relative to supply, the greater the burden paid by consumers, the smaller the deadweight loss, and the greater the government revenue

10. Government will place indirect taxes on products that have relatively inelastic demand • The demand will change in smaller proportion, gain high revenue and yet not cause a large fall in employment

11. Size of Deadweight Loss • The deadweight loss of the tax will depend upon two factors: • The size of the tax • The reduction in the quantity sold • The reduction in the quantity sold will depend upon the elasticity of demand and supply • The more elastic demand or supply is the larger the deadweight loss will be • If either demand or supply is price inelastic then the deadweight loss will be small and could be zero if perfectly inelastic (no change in the quantity sold and consumed)

12. A + B + C = Consumer Surplus (before tax) S = MC A Price buyers PB = pay B E1 maximizes Total Welfare C Price P1 = without tax E D Price sellers PS = receive F D = MB Producer Surplus = D + E + F (before tax) Q2 Q1 Total Welfare before Tax Price E1 0 QTY

13. Area C + E is a complete loss to Society: (DEADWEIGHT LOSS) S = MC A Price buyers PB = pay B C Price P1 = without tax E D Price sellers PS = receive F D = MB B + D = Tax Revenue Q2 Q1 Tax Affect on Total Welfare Price Quantity 0

14. Tax incidence and Linear Function HL Page 107 Exercise

15. Additional graphs

16. Price Consumer Surplus Maximum Willingness to Pay for Qo What is paid D Quantity Consumer Surplus Po Qo

17. Price New Consumer Surplus Original Consumer Surplus Loss in Surplus: Consumers paying more P1 Po Loss in Surplus: Consumers buying less D Qo Q1 Change in Consumer Surplus: Price Increase Quantity

18. Price Producer Surplus What is paid Minimum Amount Needed to Supply Qo Quantity Producer Surplus S Po Qo

19. Price Quantity Consumer and Producer Surplus S Consumer Surplus Po Producer Surplus D Qo

20. Price Deadweight Loss Lost Consumer Surplus New Consumer Surplus Lost Producer Surplus New Producer Surplus Quantity Loss in Efficiency Too High of Price (Price Floor) S PH Po D QL Qo

21. Price Deadweight Loss Lost Consumer Surplus New Consumer Surplus Lost Producer Surplus New Producer Surplus Quantity Loss in Efficiency Too Low of Price (Price Ceiling) S Po PL D QL Qo

22. STax Price Tax New Consumer Surplus Lost Consumer Surplus Deadweight Loss Tax Revenues Lost Producer Surplus New Producer Surplus Quantity Loss in Efficiency Taxation S PD Po PS D QL Qo

23. Subsidy

24. SSub Subsidy Gain in Producer Surplus New Consumer Surplus Gain in Consumer Surplus Deadweight Loss New Producer Surplus Subsidy Cost Loss in Efficiency Subsidy Price S PS Po PD D Qo QH Quantity