Chapter Eight: Application the costs of taxation (Level of Difficulty 1 ½)

When a tax wedge is applied on a good, a third party forms. The third party is known to be the government which measures its total revenue by the product of T (size of the tax) and Q (quantity demanded). Although the revenue is collected by the government it is spent on those who benefit. Losses to sellers and the buyers will exceed the total revenue given to government. Thus deadweight loss occurs since there is a market distortion where resources are allocated inefficiently, or without equilibrium price and quantity. Trade is also done inefficiently when a tax is placed upon a good since there is a discouragement in advantageous trade, meaning there will be a lower quantity demanded. The greater the elasticity, whether in supply or demand then the greater the deadweight loss, the same way that if a tax rises from being small to being larger the tax revenue increases as well as the deadweight loss. This trend is shown upon a gradual increasing curve that shows that as the tax size increases so does the deadweight loss. The Laffer curve on the other hand represents the trend where the larger thee tax size the less tax revenue collected, since people’s incentives change depending on the amount of taxes. In our economy how much the government gains or losses from a tax should be determined not only by tax rates, but also how it affects people’s behaviors.