Introducing Taxes and Tax Incidence - Video Tutorials & Practice Problems

Taxes and Tax Incidence

Hey guys. So I promised you we were gonna talk about taxes in this course and the time is finally upon us. Let's check it out. Alright. So first off, why are their taxes at all? Right. Why is their taxes? And that's for the government to provide public services? Right. The government collects taxes so that they can provide public services like education, right? Public education, fire police, all these services, they need money to provide it. And that comes from taxes, right? We're gonna see in this chapter that taxes will either be imposed on the buyer or the seller. Right? Someone's gonna have to pay the tax. And one note about the taxes we're going to talk about is that we're gonna be talking about per unit taxes, right? So this is a tax for each unit that is exchanged. So if the buyer is gonna be charged, let's say a $1 tax per unit. That means if you bought one of these, you pay the price of the unit and you pay an additional $1 in tax. If you were to buy two, You pay the price of the unit twice, but you pay $2 in tax, write one for each unit. So it's a per unit tax. Okay, so let's talk about this. Um what what the tax is going to do to the curves? So when we see a tax imposed on a buyer or a seller, it's going to shift that curve um by the amount of the tax. But do you think it's going to shift the curve to the left or to the right? So the idea here is going to shift to the left, right. When we talked about shifting left or right, we were talking about it being a good thing or a bad thing, right? This sounds like a bad thing. It's higher prices, right? It's going to shift the curve to the left, and it's gonna shift it by the amount of the tax. Okay? And we're gonna see this in a second, once we get down to these graphs, um I was very particular in setting these up so that you can see that uh we're shifting by the amount of the tax. Okay, So now, for the first time, we're actually gonna see a difference in the prices where the price that the consumer pays is going to be different than the amount the supplier receives. Right? And that's because the tax, so if the consumer, let's say the consumer is the one paying the tax, they're gonna pay the amount of the good plus the amount of the tax, right? And the supplier is only gonna receive the amount of the good without the tax. So there's gonna be a difference in the amounts that each one pays or receives. So for the buyer, we're gonna use this term p with a little b the price to the buyer and to the seller. We're gonna use p with this little s uh for the price to the seller. Okay. And so we talked about price, let's talk about the quantity two. So this tax when the tax is put into the market it's gonna affect our equilibrium that we're not at the equilibrium. We wanted to be right, it's gonna cause an inefficiency in the market and it's gonna force us to exchange lower quantity. So attacks always makes the quantity exchange less than the equilibrium quantity. Okay. And we'll see that on the graph as well. Last note before we hit the graphs, is that the party paying the tax? So if the tax was imposed on the buyers, it doesn't necessarily mean that they're gonna uh bear the full burden of the tax, write the tax burden actually gets split between the buyer and the seller once the market adjust. So let's go ahead and see that on the graph. Um And we'll start here with taxes on the buyer. Okay? So what we have is a situation right? We've got our price axis and our quantity axis here. And in blue we have our original situation we have our supply curve here and our original demand curve which are called D. One and S. One. Okay so in our original situation we were at this market equilibrium right here right of $6 and at that market equilibrium of $6 We were trading at this quantity Q. Star right this equilibrium quantity and the government steps in and says, alright for every unit you buy of this item, you're gonna have to pay a $2 tax. So the tax was put onto the buyers here and just like we said above, when you get um the party that gets taxed their curve is going to shift to the left by the amount of the tax. And that's exactly what we see here, effectively, the tax was $2 right? I'm gonna write that. Um I don't know. We're already all right right here, up top tax equals $2. And over here it's gonna be $2 as well once we get to the seller, so I'm just gonna write that in the taxes $2. Um And look what's happened to our demand curve. So our demand curve shifted to the left right. We've got our new demand curve here to the left and it's shifted by $2 right. If we look on the price axis, we've got a $2 shift, I did it very specifically because it's $2 All of these are going up by 1234, right? And um that is a $2 shift. We've got two squares in there, right? And that's important because I'm trying to be very specific In our range is here because I'm making a point eventually. So let's go ahead and see what happens. So in this case right, the taxes on the buyer, we shifted demand to the left. Alright. That in this box, the demand went to the left by that $2 tax. So what happens once the demand shifts, we shifted to the left and we have this new demand curve d to write our second demand curve afterwards. And sometimes actually you'll see this called D. Plus tax or if it's on the supplier s plus tax, that happens sometimes there's just a few different ways to name it. Alright, so we're at this new demand curve, right? So what is our new equilibrium here? So the new demand curve crosses the supply curve right here, right? That's gonna be the new equilibrium price of $5.10. And notice we have a lower equilibrium quantity here, right? The quantity is lower after the tax output. Q. T. Q. T. Q. T. Quantity with the tax, right? It's this lower amount. Okay, So at this price of $5.10, that's the price that's going to be exchanged and that's the amount that we're going to see the sellers receive, the sellers are gonna receive this um P. S. Of $5.10. But remember the buyers had to pay a $2 tax, right? And that's exactly what we're seeing here. So the sellers are gonna receive that 5 10. And then when the buyer gets a unit they're gonna on top of that 5 10 have to pay $2. So you're gonna see this right here, right? The price that buyers pay is actually the $7.10 right? And you'll notice that in this case it's not like the price went up by $2 to the consumer, right? You're seeing that instead of it going up from $6 to $8 you're saying that the price actually went down to 5 10 for the suppliers and up to 7 10. So the price didn't increase by the full $2 for the consumer. It was actually split a little bit. And now I want to make a point here on the right hand graph where we're gonna see that we actually end up in the same situation regardless of who pays the tax. So in this first situation the buyer was paying the tax and we ended up at these prices of $7.10 and $5.10. When the seller pays the tax of $2 in the same market, we're going to end up in the same place. So let's go ahead and see how that happens. So now let me get out of the way. Um we're gonna do the tax on the seller. So just like before um we're gonna have our original situation or supply and demand one, right? And when we have a tax on the seller, the supply line is the one that's gonna shift to the left by two units, right? So we're gonna supply shifts to the left and it's gonna be by two because we have $2 here. So we're gonna shift by $2 right? And that's exactly the length that you see here in the shift, right? This is our S. Two or s plus tax, right? And there's a $2 tax right? There? That is the shift. And that's why it shifted by that much was because it's $2. Okay, So now we've got our new supply curve and our demand curve that hasn't been affected. And let's find our new equilibrium. We'll just to note right, our old equilibrium was the same in this case, right? We still have that $6 equilibrium. And now with the tax, where is our equilibrium? So this time the supply curve shift and our Equilibrium up here at at $7.10. Right? But notice we still have a lower quantity, right? The quantity exchange is going to be lower because of the tax. So the quantity with the tax is some amount lower than the original equilibrium. But now what's happened? So in this case at this equilibrium This is the amount $7.10 again, right? That's the amount that the buyers are gonna pay right, they're gonna pay that $7.10 to the seller. And then the seller with that $7.10 is gonna take $2 and pay it to the government and be left with $5.10 right? So it doesn't matter who um pays the tax, we ended up in the same situation right here is the price to the buyers. The price to the sellers is the 5 10 and we ended up in the same situation, Right? So it's just in one case, in the first case the buyer paid the tax, right? So the supplier, um, the supplier instantly received the 5 10 and then the buyer went off and paid the $2 to the government. Right? And in the second case, the buyer just went ahead and paid the whole 7 10 to the, to the seller and the seller took from that money $2 and sent it to the government. Right. In both cases, we ended up in the same situation. So the conclusion here to make is that regardless of the tax being on the buyer or the tax being on the seller, we end up in the same place. So it doesn't matter. It does not matter if the taxes on the buyer or the seller, the answer will be the same. Okay. The only difference is which curve shifts and you'll, you'll end up in the same place. Cool. So let's talk about who's who's bearing the burden of the tax and how it's shared. So I've got this little box down here and we're going to talk about this idea of tax incidents. So tax incidents is the amount of the tax that your party is responsible for, right, the consumer is going to have a tax incidence and the producer is going to have a tax incidents. Right? So the total tax in this case was $2 right? There was a $2 tax, but how was it split? How was the share of the tax split between the consumer and the producer? Let's just talk in dollars first. So the consumers tax incidents right before they were paying $6 and now their price to the consumer P. B. Is $7.10. So out of the $2.07 dollars and 10 cents minus $6 equals a dollar 10. So the consumers are paying a dollar 10 out of the $2 in tax. Let's confirm that by going to the producer side. So before we do these these fraction boxes, let's do the producer side and the producer um before they were receiving $6 but now they're only receiving 5 10, right? So we're gonna have $6 minus the 5 10 they receive, they're gonna be paying 90 cents out of the $2 of tax, right? So that's how it split. It seems the consumer is paying a little bit more of the tax than the producer. And this all goes back. This is gonna have to do with the shapes of the curve and stuff, basically how it gets split. Um but that's not as important right now the idea is how do we do this calculation, how do we know what the tax incidence is? So this is one way they could ask you just an absolute amount. The tax incidence is a dollar 10 per unit for the consumer and 90 cents for the producer, but also, um, we could deal with it in percentages. So out of the $2 what percentage of it was the consumer paying? So we're gonna take the dollar 10 that the consumer pays out of the two total dollars, Right? And if we do that 11.1 divided by two, we're gonna get 0.55, right? Or 55%. Right? Um, so they're paying 55% of the tax. Let me get out of the way, we'll do the same thing with the producer. So the producer pays 90 cents out of every $2 of the tax and that comes out to be 0.45 or 45%. So this tax is being split 55 45 between the consumer and the producer. Right? Even though the tax could be on just one party, the incidents is split between the two. All right. So let's go ahead and go on to an example related to this topic.

Tax Incidence

Alright, let's try this example. The following graph depicts the market for a bag of magic beans, if the government imposes a tax of one cow on buyers of magic beans, what is the tax incidents on producers of magic beans? All right, so let's go ahead and look on our graph here real quick. So we've got our price which is in cows and our quantity over here, Right? And we've got a supply and the demand curve. And then we're gonna have a shift in the demand curve because there's a tax on the buyers, right? When the taxes on the buyers, the demand curve is gonna shift. And this was our original demand curve, because that's where we have this one price, right? Where we have this cross and this equilibrium going on right here. So, right, there was our original equilibrium at 2.5, right? So man, this must be some sort of dystopian future Jack in the beanstalk. Where first of all, there's been a lot of inflation, right? Jack was able to get his bag of magic beans for just one cow. And now we're talking about an equilibrium of 2.5 cows. So we're dealing in half cows, man, this society has gotten pretty weird. So anyways, at this 2.5 price, that was our original que star. Right? So let's go ahead and see what happens after this tax is imposed. So the taxes on the buyer and we're gonna shift the demand curve, just like they have here, and this is gonna be D. Two, right? That was D. One. This is D. Two or D with the tax, right? So it's asking us what is the tax incidents on producers? Right? The tax incidence is the share of the tax that that party is gonna pay in this case the producers. So what is the share of the tax to the producers? We know that the total tax was one, right? There was one cow that was being uh the additional tax here. So it's pretty easy to find it. And it's only this area here is representing the tax right between the 1.9 and the 2.9. So how do we gauge what is the amount paid by producers? Well we know that up here this 2.9 that's the price the buyers are gonna pay, right, they're gonna pay this price p. B. And the sellers are gonna receive 1.9 right? Because of that one cow tax. So um if if the original equilibrium was at 2.5, right? So sellers were originally receiving 2.5 cows per bag. Now they're only receiving 1.9 cows per bag. So what's the difference? 2.5 cows, they were originally receiving -1.9, They're paying 0.6 cows of this tax right there, taking .6 out of the one. And we can turn this into a percentage pretty quick, right 0.6 divided by the total tax which was one and that's gonna give us 0.6. Right? So that as a decimal is 60%. So 60% of this one cow tax is being paid by producers in this case, and you can see the other 40% right? The 2.9 minus the 2.5. That's being paid by the consumers in this market. All right, So that's the tax incidents on producers is gonna be 60% or 600.6 cows. Alright, let's go ahead to the next video.

If a tax is levied on the sellers of a product, the demand curve:

• A. Shifts to the left in an amount equal to the tax
• B. Shifts to the right in an amount equal to the tax
• C. Does not change
• D. Is inelastic

A tax was levied upon buyers of a good. What is the amount sellers receive after the tax is imposed? 

• A. 19
• B. 25
• C. 29
• D. None of the above