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PRINCIPLES OF MACROECONOMICSText: Principles of Macroeconomics, N. Gregory Mankiw, Sixth Edition.

Instructor: Sue Guzek, Kansas State University SalinaMusic: We Gonna Make You… By Troy “Trombone Shorty” Andrews and Orleans

Avenue – Orleans and Claiborne

APPLICATION: INTERNATIONAL TRADE

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TAXES!!! WHO BEARS THE BURDEN?

Supply Curve MarketS1S2

90

Tax on Sellers

Supply Curve MarketS1

D2

D1

Tax on Buyers

In either case, price paid by buyers rises and price received by sellers falls

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TAX WEDGE

Supply Curve MarketS

90D

100

Because of the Tax Wedge, quantity sold falls below the level sold without tax (from 100 to 90)

Tax Revenue

T X Q

Gallons of gas per month

Buyer pays $3.20

Seller receives $2.77

PriceFor example, the price of gasoline in Salina, KS

Govt. entities receive $.43 X 90 Gal per person or $37.80

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Supply Curve MarketS

90D

DEADWEIGHT LOSS

100

Decrease in total surplus (consumer + producer) that results from a market distortion, such as a tax

Deadweight Loss

- Consumer

Surplus

-Pro

duce

r Sur

plus

Tax Revenue

In this example:• Change in consumer surplus is

negative• Change in producer surplus is

negative• Change in tax revenue is positive

• Loss to buyers and sellers is greater than the revenue gained by government by the amount of triangles C and E

C

E

Taxes are an incentive to buyers to buy less and to

sellers to produce less

As buyers and sellers respond to incentives, size of the market shrinks

below optimum

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TAX DISTORTION AND ELASTICITY

The more elastic the supply, the larger the deadweight loss of tax

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DEADWEIGHT LOSS AND LABORIs supply of labor elastic???

Or inelastic???

If labor supply is Elastic, then increase in taxes will cause more people to decrease their working hours

If labor supply is INelastic, then increase in taxes will have little impact on supply of labor

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DEADWEIGHT LOSS AND TAX REVENUE

Small tax = Small Revenue

Larger tax = More Revenue

Very Large Tax = Reduced Revenue

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LAFFER CURVE – WHAT DOES IT REALLY LOOK LIKE?

IS IT THIS…Or This???

OR THIS???

What is the shape and at

what point are we on the curve???

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TERMS AND CONCEPTS

Deadweight Loss Laffer Curve

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SOURCES

Principles of Macroeconomics, N. Gregory Mankiw, Sixth Edition: PowerPoint Slides prepared by: Andreea CHIRITESCU, Eastern Illinois University