Page 169 - The Principle of Economics

(a) Small Tax
(b) Medium Tax
CHAPTER 8
APPLICATION: THE COSTS OF TAXATION 171
Deadweight loss
Supply
Demand
Tax revenue
Deadweight loss
Supply
Demand
Tax revenue
Price
PB
PS
0
Q2 Q1
Quantity
Price
PB
PS
0
Q2 Q1
Quantity
Price
PB
(c) Large Tax
Deadweight loss
Supply
Demand
PS
0 Q2 Q1 Quantity
DEADWEIGHT LOSS AND TAX REVENUE FROM THREE TAXES OF DIFFERENT SIZE. The deadweight loss is the reduction in total surplus due to the tax. Tax revenue is the amount of the tax times the amount of the good sold. In panel (a), a small tax has a small deadweight loss and raises a small amount of revenue. In panel (b), a somewhat larger tax has a larger deadweight loss and raises a larger amount of revenue. In panel (c), a very large tax has a very large deadweight loss, but because it has reduced the size of the market so much, the tax raises only a small amount of revenue.
the optimum—equals the area of the triangle between the supply and demand curves. For the small tax in panel (a), the area of the deadweight loss triangle is quite small. But as the size of a tax rises in panels (b) and (c), the deadweight loss grows larger and larger.
Indeed, the deadweight loss of a tax rises even more rapidly than the size of the tax. The reason is that the deadweight loss is an area of a triangle, and an area
Figure 8-6
Tax revenue