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652 CHAPTER 16 GENERAL EQUILIBRIUM THEORY
We have just gone through a simple general equilibrium analysis. This analysis is
significant for two reasons. First, we see that events in the coffee market cannot neces-
sarily be viewed in isolation: The decrease in coffee supply had a significant impact on
the price of tea. Second, because coffee and tea are substitutes, an exogenous event in
the coffee market, for example, bad weather, that tends to increase the price of coffee,
will also tend to increase the price of tea; similarly, an exogenous event that tends to
decrease the price of coffee will also tend to decrease the price of tea. This tells us that
the prices of substitute goods will tend to be positively correlated.

APPLICA TION 16.1
Net after Taxes? purchases. Technically, those consumers are supposed
to calculate their sales tax and send it to their state’s
The last time you purchased a product on the Internet— tax agency, but few consumers actually do so. Thus, a
a book, a CD, or even a personal computer—you proba- large percentage of Internet sales across state lines are
bly did not pay a sales tax on the transaction. This is not effectively tax free, which provides a competitive ad-
because such transactions do not involve taxes; they vantage for online retailers.
usually do. Rather, the burden is on you, the buyer, to This tax advantage for online retailers may not
calculate and pay the state and local sales taxes on the last for long. In 2008, New York State passed a law
items that you buy. (If you don’t believe us, read the requiring online retailers to collect sales taxes from
fine print on the invoice for your purchase. It will prob- residents of New York if that retailer provides sales
ably say something like, “The purchaser is responsible referrals to any New York-based website. Amazon
for remitting any additional taxes to the taxing author- not only sells products directly, but the site also acts
ity.”) This is in contrast to sales in traditional retail outlets. as an aggregator that in effect channels buyers to
When you buy a CD at your local music store, for exam- other sellers, all over the United States. Therefore,
ple, the store owner is responsible for paying the tax to Amazon will be subject to the New York tax rule if it
the relevant tax authority, not you. Of course, with mil- is ultimately upheld in court. North Carolina and
lions of individual consumer transactions on the Web Rhode Island have now passed similar laws; California,
every day, it is nearly impossible for state and local gov- Virginia, Illinois, Colorado and Hawaii are consider-
ernments to force consumers to pay the sales taxes that ing doing the same. 1
they owe. What would happen if states were allowed to
The most straightforward way around this prob- collect sales taxes directly from sellers? Let’s use gen-
lem would be to treat Internet transactions like tradi- eral equilibrium analysis to explore this question. In
tional retail transactions and require sellers to remit particular, we want to examine the impact of this
the sales taxes, not consumers. However, states are not policy not only on the prices of products such as CDs
legally allowed to assess sales taxes on goods sold by and books that are purchased online, but also on the
companies outside of their own state. In order to assess prices of services, such as the provision of Internet
taxes on an Internet purchase, the company must have access—subscription to online services that allow you
a “physical presence” (such as a store, office, or distri- to connect to the Web.
bution warehouse) in the state to which the goods are Figure 16.3 analyzes what might happen. In a
shipped. For example, Amazon.com is the world’s typical e-tail market such as the market for CDs, the
largest Internet retailer. It has a physical presence in the imposition of a requirement that sellers pay the sales
states of Kansas, Kentucky, New York, North Dakota, tax would raise the marginal cost of a typical CD seller,
and Washington, so consumers who live in those states which, as shown in Figure 16.3(a), would shift the
are assessed state sales taxes by Amazon. Consumers supply curve for online CD sales leftward, from S CD to
living in other states are not assessed taxes on Amazon S CD . As a result, the price of CDs sold online would go

1 Evan Halper, “Lawmakers Want to Tax Amazon Sales in California.” Los Angeles Times (February 20, 2010).