Chapter 8 Summary

Chapter 8 was relatively simple and easy to understand. It discussed in more detail the costs of taxation that were introduced in the previous chapter. Taxes are necessary to allow government to carry out its necessary functions; however, they have a cost on welfare--that is, the total economic well-being of a market. This is closely related to the idea of surplus. The cost of taxation ends up being higher than the revenue raised by the government. Tax revenue is equal to the area to the left of the tax wedge--that is, the area between what buyers pay and what sellers receive and the quantity sold. This benefit to government is eventually passed back along to consumers and producers who the government spends the revenue to benefit. When a tax is passed, the losses to buyers and sellers exceed the revenue raised by the government. This is the deadweight loss of the tax and is represented by the triangle between the tax wedge and the 2 curves. The deadweight loss is caused by the distortion of incentives the tax creates, which prevents some buyers and sellers from carrying out trades that otherwise would be mutually beneficial. The size of the deadweight loss is determined by the elasticities of supply and demand. The greater the elasticities of supply and demand, the greater the deadweight loss, which is logical because a change in price due to the tax will produce a larger change in quantity for more elastic markets. The Laffer curve shows that a larger tax can actually reduce revenue in addition to increasing deadweight loss.