Page 542 - Krugmans Economics for AP Text Book_Neat

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.

figure 50.5

The Supply and Demand for Price of
hotel room
Hotel Rooms in Potterville
In the absence of taxes, the equilibrium price of $140
hotel rooms is $80 a night, and the equilibrium
number of rooms rented is 10,000 per night, as 120
shown by point E. The supply curve, S, shows the
quantity supplied at any given price, pre-tax. At a 100 S
price of $60 a night, hotel owners are willing to
Equilibrium E
supply 5,000 rooms, as shown by point B. But 80
price
post-tax, hotel owners are willing to supply the
B
same quantity only at a price of $100: $60 for 60 D
themselves plus $40 paid to the city as tax.
40
20

0 5,000 10,000 15,000
Quantity of
hotel rooms
Equilibrium
quantity

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.

500 section 9 Behind the Demand Curve: Consumer Choice