AP_Krugman_Textbook

can choose to move to other towns. Furthermore, the price elasticity of supply is often
low because most sellers must sell their houses due to job transfers or to provide
funds for their retirement. So taxes on home purchases are actually paid mainly by the
less well-off sellers—not, as town officials imagine, by wealthy buyers.

The Benefits and Costs of Taxation

When a government is considering whether to impose a tax or
how to design a tax system, it has to weigh the benefits of a tax
against its costs. We may not think of a tax as something that
provides benefits, but governments need money to provide
things people want, such as streets, schools, national defense,
and health care for those unable to afford it. The benefit of a
tax is the revenue it raises for the government to pay for these
services. Unfortunately, this benefit comes at a cost—a cost
that is normally larger than the amount consumers and pro-
ducers pay. Let’s look first at what determines how much
money a tax raises and then at the costs a tax imposes.

The Revenue from an Excise Tax

How much revenue does the government collect from an excise tax? In our hotel tax ex-
ample, the revenue is equal to the area of the shaded rectangle in Figure 50.10.

module 50 Efficiency and Deadweight Loss 505

Section 9 Behind the Demand Curve: Consumer Choice

istockphoto

figure 50.10

The Revenue from an

Excise Tax

The revenue from a $40 excise tax on hotel

rooms is $200,000, equal to the tax rate,

$40—the size of the wedge that the tax drives

between the supply price and the demand

price—multiplied by the number of rooms

rented, 5,000. This is equal to the area of the

shaded rectangle.

S

B

0 5,000 10,000 15,000

$140

120

100

80

60

40

20

Quantity of hotel rooms

D

Area = E

tax revenue

Excise tax

= $40 per room

A

Price of

hotel room

To see why this area represents the revenue collected by a $40 tax on hotel rooms, no-
tice that the heightof the rectangle is $40, equal to the tax per room. It is also, as we’ve
seen, the size of the wedge that the tax drives between the supply price (the price received
by producers) and the demand price (the price paid by consumers). Meanwhile, the width
of the rectangle is 5,000 rooms, equal to the equilibrium quantity of rooms given the
$40 tax. With that information, we can make the following calculations.
The tax revenue collected is:

Tax revenue =$40 per room ×5,000 rooms =$200,000