Chapter 8: Application: The Costs of Taxation
Principles of Economics, 6th Edition
N. Gregory Mankiw
Page 1
1. The Deadweight Loss of Taxation
a. How A Tax Affects Market Participants
i. It drives a wedge between the price that the buyer pays and the price
the seller receives.
ii. Figure 1: The Effects of a Tax. P. 156
iii. Figure 2: Tax Revenue. P. 157
iv. Welfare without a tax
(1) Figure 3: How a Tax Affects Welfare. P. 158
v. Welfare with a Tax
vi. Changes in Welfare
The losses to buyers and sellers from a tax exceed the revenue raised
by the government.
Def: Deadweight loss is the reduction in total surplus that results
from a tax. P. 158
a. Deadweight Losses And The Gains From Trade
i. Taxes cause deadweight losses because they prevent buyers and
sellers from realizing some of the gains from trade.
ii. Figure 4: The Deadweight Loss. P. 160
2. Determinants Of The Deadweight Loss
a. Demand and supply elasticities
i. The greater the elasticities of supply and demand, the greater the
deadweight loss of a tax.
b. Figure 5: Tax Distortions and Elasticities. P. 161
c. Case Study: The Deadweight Loss Debate, P. 162
3. Deadweight Loss And Tax Revenue As Taxes Vary
a. The DWL rises more quickly than the tax.
i. A doubling of the tax causes the DWL to increase by 4.
ii. A tripling of the tax causes the DWL to increase by 9.
b. Figure 6: Deadweight Loss and Tax Revenue Vary with the Size of a
Tax, P. 164
i. When taxes are very high, a cut in the tax rate can increase tax
revenues.
c. Case Study: The Laffer Curve and Supply-side Economics, P. 165
i. The relationship between tax rates and tax revenues.
d. In the News: New Research on Taxation, P. 166.
4. Conclusion
5. Summary
