Micro: Unit 1.5 -- Excise Taxes and Tax Incidence

Summary

In this video, Mr. Wallace explores the concept of excise taxes, detailing how the government can intervene in markets to reduce negative externalities. Through real-life examples of goods like Good C, Good F, and Good S, he explains how excise taxes affect the price, quantity, and market dynamics. The video also covers tax incidence, illustrating how the burden of the tax is shared between producers and consumers based on elasticity. The lesson highlights the effects of taxes on firms' revenue and the overall market behavior, offering a clear understanding of economic principles related to taxation.

Takeaways

• 😀 Excise taxes are per-unit duties imposed on specific goods to reduce production or consumption of undesirable products, aiming to decrease negative externalities.
• 😀 The government uses excise taxes to reduce harmful effects associated with certain goods by making them more expensive and less accessible to consumers.
• 😀 When a per-unit tax is levied, it shifts the supply curve left, raising the product price and reducing the equilibrium quantity in the market.
• 😀 In a market with a $4 excise tax on goods C, the price increases from $5 to $7, and the output decreases from 400 to 200 units, reducing negative externalities.
• 😀 Tax incidence refers to the division of the tax burden between firms and consumers, and it depends on the price elasticity of demand.
• 😀 If demand is inelastic, consumers will bear most of the tax burden because they are less responsive to price changes.
• 😀 If demand is elastic, firms will bear more of the tax burden because consumers are more sensitive to price increases.
• 😀 In a scenario with an inelastic demand for good F, consumers paid two-thirds of the $3 tax, while producers paid the remaining third.
• 😀 For goods with elastic demand, like good S, the tax burden is shared more equally between consumers and producers, with producers shouldering a larger portion.
• 😀 The total tax revenue generated from an excise tax can be calculated by multiplying the per-unit tax by the number of units sold after the tax is imposed.
• 😀 Elasticity plays a crucial role in determining how much of the tax burden will be passed on to consumers, influencing market behavior and tax incidence.

Q & A

What is an excise tax, and what is its purpose?

An excise tax is a per-unit duty levied on specific goods. Its purpose is to manipulate the price and quantity of a product in order to meet social goals, such as reducing negative externalities or limiting the production of undesirable goods.

How does an excise tax reduce the negative externalities of a good?

By imposing an excise tax, the government increases the cost of production for firms, which leads to a decrease in the quantity of the good produced. This reduction in output helps minimize the negative externalities associated with the good's production.

What happens in the market when an excise tax is imposed on a good?

When an excise tax is imposed, the supply curve shifts leftward by the amount of the tax. This results in an increase in the price of the good and a decrease in the quantity produced and consumed, as the tax raises the cost of production.

What is meant by 'tax incidence' in the context of excise taxes?

Tax incidence refers to the distribution of the tax burden between producers and consumers. It determines how much of the tax is paid by each party, and it depends on the price elasticity of demand and supply.

How do firms respond to an excise tax to minimize their tax burden?

Firms will reduce the quantity of the good they produce in order to minimize the amount of tax they have to pay. By producing fewer units, they decrease the total tax liability.

How is the tax incidence determined in a market after the imposition of an excise tax?

To determine tax incidence, we compare the price consumers pay after the tax to the original price. The change in price, along with the reduction in quantity, reveals how the tax burden is shared between producers and consumers.

Why do firms and consumers share the tax burden? How does the elasticity of demand affect this sharing?

Firms and consumers share the tax burden because firms cannot pass the entire tax onto consumers without reducing demand. The elasticity of demand affects how the burden is shared: if demand is inelastic, consumers bear more of the burden, while if demand is elastic, firms bear more of the burden.

How does the price elasticity of demand influence who bears the majority of the excise tax burden?

If demand is inelastic (consumers need the product), consumers will bear a larger portion of the tax burden, as they are less responsive to price changes. If demand is elastic (the product is a luxury or non-essential), firms will bear more of the tax burden to avoid significant drops in demand.

In the example of good F (a product with inelastic demand), how did the imposition of the excise tax affect the price and the quantity produced?

The price of good F increased from $7 to $9, and the quantity produced decreased from 1,000 to 900 units. Since demand was inelastic, the majority of the tax burden was passed onto consumers, with firms retaining a smaller share of the tax burden.

In contrast, how did the imposition of the excise tax affect the price and the quantity produced for good S (a luxury product with elastic demand)?

For good S, the price increased from $10 to $11, and the quantity produced decreased from 500 to 300 units. Since demand for good S was elastic, firms paid the majority of the tax burden, as consumers were more responsive to the price increase.