AP_Krugman_Textbook

The upward shift of the supply curve caused by the tax is shown in Figure 50.6,
whereS 1 is the pre-tax supply curve and S 2 is the post-tax supply curve. As you can see,
the market equilibrium moves from E,at the equilibrium price of $80 per room and
10,000 rooms rented each night, to A,at a market price of $100 per room and only
5,000 rooms rented each night. Ais, of course, on both the demand curve Dand the
new supply curve S 2. In this case, $100 is the demand price of 5,000 rooms—but in ef-
fect hotel owners receive only $60, when you account for the fact that they have to pay
the $40 tax. From the point of view of hotel owners, it is as if they were on their original
supply curve at point B.

module 50 Efficiency and Deadweight Loss 501

Section 9 Behind the Demand Curve: Consumer Choice

figure 50.6

An Excise Tax Imposed on

Hotel Owners

A $40 per room tax imposed on hotel

owners shifts the supply curve from S 1 to

S 2 , an upward shift of $40. The equilib-

rium price of hotel rooms rises from $80

to $100 a night, and the equilibrium quan-

tity of rooms rented falls from 10,000 to

5,000. Although hotel owners pay the tax,

they actually bear only half the burden:

the price they receive net of tax falls only

$20, from $80 to $60. Guests who rent

rooms bear the other half of the burden

because the price they pay rises by $20,

from $80 to $100.

S 1

S 2

A

B

0 5,000 10,000 15,000

$140

120

100

80

60

40

20

Quantity of

hotel rooms

Price of

hotel room

D

Excise tax E

= $40 per room

Supply curve

shifts upward by the

amount of the tax.

Let’s check this again. How do we know that 5,000 rooms will be supplied at a price
of $100? Because the price net of taxis $60, and according to the original supply curve,
5,000 rooms will be supplied at a price of $60, as shown by point Bin Figure 50.6.
An excise tax drives a wedgebetween the price paid by consumers and the price
received by producers. As a result of this wedge, consumers pay more and producers
receive less. In our example, consumers—people who rent hotel rooms—end up
paying $100 a night, $20 more than the pre-tax price of $80. At the same time,
producers—the hotel owners—receive a price net of tax of $60 per room, $20 less
than the pre-tax price. In addition, the tax creates missed opportunities: 5,000 po-
tential consumers who would have rented hotel rooms—those willing to pay $80 but
not $100 per night—are discouraged from renting rooms. Correspondingly, 5,000
rooms that would have been made available by hotel owners when they receive $80
are not offered when they receive only $60. Like a quota on sales as discussed in
Module 9, this tax leads to inefficiency by distorting incentives and creating missed
opportunities for mutually beneficial transactions.
It’s important to recognize that as we’ve described it, Potterville’s hotel tax is a tax
on the hotel owners, not their guests—it’s a tax on the producers, not the consumers.
Yet the price received by producers, net of tax, is down by only $20, half the amount of
the tax, and the price paid by consumers is up by $20. In effect, half the tax is being
paid by consumers.