Just to review what we've talked about before, up here, below the demand curve and above the price. This is how much value, this is how much benefit the consumers are getting above and beyond what they have to pay. That is the consumer surplus. This is how much more the producers are getting for each hamburger, relative to what their opportunity cost of producing that incremental hamburger was.
This right over here is the producer surplus. Now, let's say Actually these numbers are quasi-realistic. I have a 3. I actually looked it up before this video. It looks like McDonalds, at least based on the information I got, sells a little bit over 4 million hamburgers per day in the United States.
I didn't clarify whether this is just hamburgers from one vendor or multiple vendors, but it's not a crazy number of hamburgers to sell in a fairly large country. For the sake of this, it's not necessarily McDonalds hamburgers, we're just talking about this is the total market for hamburgers in a country.
We're making the simplifying assumption that all hamburgers are created equal, which we know is not true. Now, the government in this hypothetical civilization says, "Wow, a lot of hamburgers are being sold.
So they decide to tax hamburgers. They want to tax hamburgers. They're going to make it very simple. They're not even going to do a percentage. Let's think about what this does to the surplus, to the price at which transactions will go on and what people will have to pay versus what they will have to get. The more hamburgers you want the suppliers to produce you have to pay them more and more for those incremental hamburgers, because they're going to start using resources that might have better used for other things and that are not as efficiently used for hamburgers.
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Your Reason has been Reported to the admin. Because these buyers and sellers do not participate in the market, they do not contribute to the tax, which is why the government does not receive the portion consisting of the deadweight loss.
Instead, the taxes are paid by the buyers and sellers who continue to participate in the market. The buyers pay part of the tax, in an economic sense, as a reduction in their consumer surplus , which is the difference between their willingness-to-pay price and the product price. Likewise, sellers pay part of the tax as a reduction in their producer surplus.
This loss, however, goes to the government in the form of its tax, which makes sense, since only the buyers that continue to buy the product and the sellers who continue to sell the product contribute to the tax. The amount of the deadweight loss varies with both demand elasticity and supply elasticity. When either demand or supply is inelastic, then the deadweight loss of taxation is smaller, because the quantity bought or sold varies less with price.
With perfect inelasticity, there is no deadweight loss. However, deadweight loss increases proportionately to the elasticity of either supply or demand. Who suffers the tax burden also depends on elasticity. When supply is inelastic or demand is elastic, then the seller suffers the major tax burden, as can be seen in the orange-shaded areas in graphs 2 and 4 , above; when supply is elastic or demand is inelastic, then the buyer pays most of the tax Graphs 1 and 3.
Of course, the effect of elasticity on the tax is no different from its effect on any other price change. Tax revenue varies with the proportion of the tax as a percentage of the product price. Usually, a moderate tax rate will yield the most tax revenue, as can be seen from the first diagram above.
When the tax rate is small or high, tax revenue will be less. When the tax rate is small, the government only gets a small portion of the price paid. When the tax rate is high, then the quantity sold is much less, so even when it is multiplied by the high tax rate, it yields less revenue, which can be seen in the diagrams below. Also illustrated is that the deadweight loss of a high tax rate is much greater than the deadweight loss of a low tax rate.
A high tax rate, as a low tax rate, yields little government revenue, but the high tax rate comes at a bigger expense to the economy, since it reduces total surplus more: fewer people will be able to enjoy the goods and services subject to the high tax rate. Of course, this is desirable for excise taxes on goods or services that are detrimental to people or society, such as tobacco and alcohol consumption.
In this case, a high tax rate not only earns some revenue for the government, but also promotes more desirable goals. Federal, state, and local governments frequently decide to raise taxes in order to raise revenues to cover shortfalls.
Although this action may seem like a good idea, it often has the opposite effect. This is called a deadweight loss of taxation or, simply, a deadweight loss. Here's how it works. When the government raises taxes on certain goods and services, it collects that tax as additional revenue.
Taxes, though, result in a higher cost of production and a higher purchase price for the consumer. This, in turn, causes production volumes and, therefore, supply to drop, leading to a drop in demand for these goods and services. This gap between the taxed and tax-free production volumes is the deadweight loss.
This theory was developed by Alfred Marshall, an economist who specialized in microeconomics. According to Marshall, supply and demand are directly related to production and cost. These points intersect in the middle. So, when one changes, it throws off the balance. Although there isn't a consensus among experts about whether deadweight loss can be accurately measured, many economists agree that taxation can often be counter-productive. This makes a deadweight loss of taxation a lost opportunity cost.
Deadweight loss of taxation may be viewed as the overall reduction in demand and the subsequent decline in production levels that follow the imposition of a tax, which is usually represented graphically. Taxation reduces the returns from investments, wages, rents, and entrepreneurship.
This, in turn, reduces the incentive to invest, work, deploy property , and take risks. But it also encourages taxpayers to spend time and money trying to avoid their tax burden, diverting valuable resources from other productive uses. Most governments levy taxes disproportionately on different people, goods, services, and activities. This distorts the natural market distribution of resources.
The limited resources will move from their otherwise optimal use, away from heavily taxed activities and into lightly taxed activities, which may not be advantageous to all. The economics of taxation also apply to other forms of government financing.
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