Page 165 - The Principle of Economics

Supply
When supply is relatively inelastic, the deadweight loss of a tax is small.
Size of tax
Demand
When supply is relatively elastic, the deadweight loss of a tax is large.
Size of tax
Supply
Demand
Price
Price
0
Price
Quantity 0
Price
Quantity
(a) Inelastic Supply
(b) Elastic Supply
(c) Inelastic Demand
(d) Elastic Demand
CHAPTER 8
APPLICATION: THE COSTS OF TAXATION 167
Size of tax
Supply
When demand is relatively inelastic, the deadweight loss of a tax is small.
Demand
Size of tax
Supply
Demand
When demand is relatively elastic, the deadweight loss of a tax is large.
0
Quantity 0
Quantity
Figure 8-5
TAX DISTORTIONS AND ELASTICITIES. In panels (a) and (b), the demand curve and the size of the tax are the same, but the price elasticity of supply is different. Notice that the more elastic the supply curve, the larger the deadweight loss of the tax. In panels (c) and (d), the supply curve and the size of the tax are the same, but the price elasticity of demand is different. Notice that the more elastic the demand curve, the larger the deadweight loss of the tax.
Let’s consider first how the elasticity of supply affects the size of the dead- weight loss. In the top two panels of Figure 8-5, the demand curve and the size of the tax are the same. The only difference in these figures is the elasticity of the sup- ply curve. In panel (a), the supply curve is relatively inelastic: Quantity supplied responds only slightly to changes in the price. In panel (b), the supply curve is