Chapter 8: The Costs of Taxation

Chapter 8 builds on the concept of tax wedges presented in Chapter 6. When a tax is imposed in a market, it drops a wedge between the buyers and the sellers. As we already learned, the buyers pay a higher price, and the sellers receive a lower price. The price difference represents the size of the tax, which is collected by the government. The size of the tax represents the price of the tax collected by the government, and the price multiplied by the quantity is the tax revenue collected by the government. Although the tax revenue decreases the consumer and producer surplus, the tax revenue is still a part of the total surplus. Although the tax revenue is a part of total surplus, the total surplus reduces due to the tax. With the tax in place, there is a deadweight loss, which are the transactions which don't take place because of an inefficiency in the market. The deadweight loss is larger with a more elastic curve, and it grows larger with the size of the tax.