RMIT Classification: Trusted

Chapter 5
Market Outcomes and Tax
Incidence

Copyright © 2021 by W. W. Norton & Company, Inc.

Big Questions

1. What are consumer surplus and producer surplus?

2. When is a market efficient?

3. Why do taxes create deadweight loss in otherwise efficient

markets?

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Market Outcomes and Tax Incidence

• Consumer Surplus

• Willingness to pay (WTP)

• WTP – Price

• Producer Surplus

• Willingness to sell (WTS)

• Price – WTS

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Market Outcomes and Tax Incidence

• Market Efficiency

• Tax Incidence

• No difference whether levied on consumers or business.

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What Are Consumer and Producer

• Welfare economics:

• Welfare is composed of two measures of market value:

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Consumer Surplus—1

Suppose three government employees—Ron, Leslie, and Donna—

need to enroll in an economics course. They all have a different

willingness to pay (WTP) for a college economics textbook.

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Consumer Surplus—2

Who buys the book if the price is $140?

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Consumer Surplus—3

What is consumer surplus?

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Using Demand to Illustrate Consumer

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Consumer Surplus, Graphically—1

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Consumer Surplus, Graphically—2

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Producer Surplus—1

• Suppose that three people—Ann, April, and Andy—opt out of the

economics course, and decide to go into the tutoring business.

• What is their willingness to sell (WTS)?

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Producer Surplus—2

Which students will tutor if the market price is $25 per hour?

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Producer Surplus—3

What is producer surplus?

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Using Supply to Illustrate Producer

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Producer Surplus, Graphically—1

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Producer Surplus, Graphically—2

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Practice What You Know—1

The height of the demand curve at any quantity can be thought of as

the

A. willingness to buy.

B. willingness to sell.

C. consumer surplus.

D. producer surplus.

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Practice What You Know—2

The difference between the price the good was sold at and the

minimum price the firm would have accepted for the good is called

A. willingness to sell.

B. product markup.

C. producer surplus.

D. price-cost margin.

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When Is a Market Efficient?

• How do economists measure social welfare?

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C.S. and P.S. for a Slice of Pie—1

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C.S. and P.S. for a Slice of Pie—2

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Taxation, Welfare, and Deadweight

• Why do we pay taxes?

• What are some different types of taxes?

• What are excise taxes?

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Tax Incidence

• Suppose the government imposes an excise tax on milk.

• Who pays for the tax?

• Tax incidence:

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Tax on Buyers

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Tax on Sellers

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Comparing Both Cases

• Tax levied on consumers:

• Tax levied on a business:

• Incidence:
•

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Deadweight Loss

• So far we have shown that a tax hurts both buyers and sellers.

• Buyers pay a ________ price, and sellers receive a ________

price.

• What did we miss?

• What is deadweight loss?

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Deadweight Loss, Graphically

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Practice What You Know—3

Deadweight loss can be thought of as surplus that is transferred from

producers or consumers and given to

A. the government.

B. competitors in other markets.

C. taxpayers.

D. nobody.

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Balancing Deadweight Loss and Tax

• What happens if the government increases a tax?

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Deadweight Loss and Tax Revenue—

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Deadweight Loss and Tax Revenue—

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Deadweight Loss and Tax Revenue—

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Deadweight Loss and Tax Revenue—

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Deadweight Loss and Tax Revenue—

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Conclusion

• Unregulated markets are beneficial because they generate the

• Taxing specific goods leads to a deadweight loss, which reflects

• Society must balance the benefits of government services that

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