AP_Krugman_Textbook

are common. For example, there are excise taxes on gasoline, cigarettes, and foreign-

made trucks, and many local governments impose excise taxes on services such as hotel

room rentals. The lessons we’ll learn from studying excise taxes apply to other, more

complex taxes as well.

The Effect of an Excise Tax on Quantities and Prices

Suppose that the supply and demand for hotel rooms in the city of Potterville are as

shown in Figure 50.5. We’ll make the simplifying assumption that all hotel rooms are

the same. In the absence of taxes, the equilibrium price of a room is $80 per night and

the equilibrium quantity of hotel rooms rented is 10,000 per night.

500 section 9 Behind the Demand Curve: Consumer Choice

figure 50.5

The Supply and Demand for

Hotel Rooms in Potterville

In the absence of taxes, the equilibrium price of

hotel rooms is $80 a night, and the equilibrium

number of rooms rented is 10,000 per night, as

shown by point E.The supply curve, S,shows the

quantity supplied at any given price, pre-tax. At a

price of $60 a night, hotel owners are willing to

supply 5,000 rooms, as shown by point B.But

post-tax, hotel owners are willing to supply the

same quantity only at a price of $100: $60 for

themselves plus $40 paid to the city as tax.

S

D

0 5,000 10,000 15,000

$140

120

100

80

60

40

20

Quantity of

hotel rooms

Price of

hotel room

E

B

Equilibrium

quantity

Equilibrium

price

Now suppose that Potterville’s government imposes an excise tax of $40 per night

on hotel rooms—that is, every time a room is rented for the night, the owner of the

hotel must pay the city $40. For example, if a customer pays $80, $40 is collected as a

tax, leaving the hotel owner with only $40. As a result, hotel owners are less willing to

supply rooms at any given price.

What does this imply about the supply curve for hotel rooms in Potterville? To an-

swer this question, we must compare the incentives of hotel owners pre-tax (before the

tax is levied) to their incentives post-tax(after the tax is levied). From Figure 50.5 we

know that pre-tax, hotel owners are willing to supply 5,000 rooms per night at a price

of $60 per room. But after the $40 tax per room is levied, they are willing to supply the

same amount, 5,000 rooms, only if they receive $100 per room—$60 for themselves

plus $40 paid to the city as tax. In other words, in order for hotel owners to be willing

to supply the same quantity post-tax as they would have pre-tax, they must receive an

additional $40 per room, the amount of the tax. This implies that the post-tax supply

curve shifts up by the amount of the tax compared to the pre-tax supply curve. At every

quantity supplied, the supply price—the price that producers must receive to produce a

given quantity—has increased by $40.