5 Steps to a 5 AP Microeconomics, 2014-2015 Edition

• Conversely, as the price elasticity of demand rises and the price elasticity of supply falls,
  the producer’s share of a per unit excise tax rises.

Loss to Society

There is also a cost to society when an excise tax is imposed on a competitive market.

In the hypothetical soda market depicted in Figure 7.12, the equilibrium quantity is 100

and the equilibrium price is $1. At this point, the marginal benefit to society exactly equals

the marginal cost and net benefit; total welfare (combined consumer and producer surplus)

is the greatest. When a $l excise tax is imposed, the price of sodas increases to $1.80 and

the amount of sodas consumed decreases to 80. The government collects $80 =$1 ¥80 in

tax revenue. With the tax, consumers and producers demand and supply 20 fewer units

than without the tax. For these 20 units that go unproduced, the marginal benefit to con-

sumers exceeds the marginal costs to producers. The fact that these 20 units go unproduced

and unconsumed results in an inefficient outcome. The triangle labeled DWL used to be

earned by society in the form of consumer and producer surplus. With the excise tax, soci-

ety loses this area; it goes to no one. Economists call this area deadweight loss(DWL), or

the net benefit sacrificed by society when such a per unit tax is imposed. Since the key to

deadweight loss is a large decrease in quantity below the untaxed outcome, the area of dead-

weight loss to society increases as the demand or supply curves get more elastic.

Note: Taxes such as these are not the only sources of distortions away from market effi-

ciency. For example, production often generates pollution (a negative externality), which

creates a situation where harmful spillover costs are incurred by third parties. Left unregu-

lated, these costs are not captured by the market price and the market will not produce the

“correct” amount of a good. These sources of inefficiency, or market failures, are addressed

in Chapter 11.

Elasticity, Microeconomic Policy, and Consumer Theory ‹ 87

Quantity

Price $ ST

S 0

D 0

T= 1.00

100

1.00

1.80

80

W

L

D

Figure 7.12

• Taxes create lost efficiency by moving away from the equilibrium market quantity
  where MB =MC to society.


• The area of deadweight loss (triangle DWL) increases as the quantity moves further
  from the competitive market equilibrium quantity.

Subsidies

A per unit subsidy on good X has the opposite effect of an excise tax, because firms

respond as if the subsidy has lowered the marginal cost of production, therefore resulting

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