AP_Krugman_Textbook

What would happen if the city levied a tax on consumers instead of producers? That

is, suppose that instead of requiring hotel owners to pay $40 a night for each room they

rent, the city required hotel gueststo pay $40 for each night they stayed in a hotel. The

answer is shown in Figure 50.7. If a hotel guest must pay a tax of $40 per night, then

the price for a room paid by that guest must be reduced by $40 in order for the quantity

of hotel rooms demanded post-tax to be the same as that demanded pre-tax. So the de-

mand curve shifts downward,fromD 1 toD 2 , by the amount of the tax. At every quantity

demanded, the demand price—the price that consumers must be offered to demand a

given quantity—has fallen by $40. This shifts the equilibrium from EtoB,where the

market price of hotel rooms is $60 and 5,000 hotel rooms are bought and sold. In ef-

fect, hotel guests pay $100 when you include the tax. So from the point of view of

guests, it is as if they were on their original demand curve at point A.

502 section 9 Behind the Demand Curve: Consumer Choice

figure 50.7

An Excise Tax Imposed on

Hotel Guests

A $40 per room tax imposed on hotel guests

shifts the demand curve from D 1 toD 2 , a

downward shift of $40. The equilibrium price

of hotel rooms falls from $80 to $60 a night,

and the quantity of rooms rented falls from

10,000 to 5,000. Although in this case the tax

is officially paid by consumers, while in Figure

50.6 the tax was paid by producers, the out-

come is the same: after taxes, hotel owners

receive $60 per room but guests pay $100.

This illustrates a general principle: The inci-

dence of an excise tax doesn’t depend on

whether consumers or producers officially pay

the tax.

A

B

0 5,000 10,000 15,000

$140

120

100

80

60

40

20

Quantity of

hotel rooms

E

S

D 2

D 1

Excise tax

= $40 per room

Demand curve

shifts downward

by the amount

of the tax.

Price of

hotel room

If you compare Figures 50.6 and 50.7, you will notice that the effects of the tax are

the same even though different curves are shifted. In each case, consumers pay $100

per unit (including the tax, if it is their responsibility), producers receive $60 per unit

(after paying the tax, if it is their responsibility), and 5,000 hotel rooms are bought and

sold.In fact, it doesn’t matter who officially pays the tax—the equilibrium outcome is the same.

This example illustrates a general principle of tax incidence,a measure of who re-

ally pays a tax: the burden of a tax cannot be determined by looking at who writes the

check to the government. In this particular case, a $40 tax on hotel rooms brings about

a $20 increase in the price paid by consumers and a $20 decrease in the price received

by producers. Regardless of whether the tax is levied on consumers or producers, the

incidence of the tax is the same. As we will see next, the burden of a tax depends on the

price elasticities of supply and demand.

Price Elasticities and Tax Incidence

We’ve just learned that the incidence of an excise tax doesn’t depend on who offi-

cially pays it. In the example shown in Figures 50.5 through 50.7, a tax on hotel

rooms falls equally on consumers and producers, no matter on whom the tax is

Tax incidenceis the distribution of the
tax burden.