Page 544 - Krugmans Economics for AP Text Book_Neat

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 guests to 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, from D 1 to D 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 E to B, 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.

figure 50.7

An Excise Tax Imposed on Price of
hotel room
Hotel Guests
A $40 per room tax imposed on hotel guests $140
Demand curve
shifts the demand curve from D 1 to D 2 , a
downward shift of $40. The equilibrium price 120 shifts downward
by the amount
of hotel rooms falls from $80 to $60 a night,
A of the tax. S
and the quantity of rooms rented falls from 100
10,000 to 5,000. Although in this case the tax
Excise tax E
is officially paid by consumers, while in Figure 80
= $40 per room
50.6 the tax was paid by producers, the out-
come is the same: after taxes, hotel owners 60 D
receive $60 per room but guests pay $100. B 1
This illustrates a general principle: The inci- 40
dence of an excise tax doesn’t depend on
whether consumers or producers officially pay 20 D
the tax. 2

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

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-
Tax incidence is the distribution of the cially pays it. In the example shown in Figures 50.5 through 50.7, a tax on hotel
tax burden. rooms falls equally on consumers and producers, no matter on whom the tax is
502 section 9 Behind the Demand Curve: Consumer Choice