[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

PRICE OF CIGARETTES
Price paid by
consumers
Price
without tax
Price received
by producers
A
A tax on cigarettes
Supply curve
after tax
Supply curve
before tax
Q 1
QUANTITY OF CIGARETTES (Q )
Tax
PRICE OF CHEDDAR
Price paid by
consumers
B
A tax on cheddar cheese
Supply curve
after tax
Price
without tax
Tax
Price received
Demand
by producers
curve
Supply curve
before tax
Q 0 Q 1 Q 0
QUANTITY OF CHEDDAR (Q )
Demand
curve
Figure 10.3
TAXES AND EFFICIENCY
A tax on the output of an industry shifts the supply curve up by the amount of the tax.
Panel A shows that if the demand curve is relatively inelastic, as is the case with cigarettes,
most of the tax is passed on to consumers. Both consumer surplus and producer
surplus fall, but most of the tax burden falls on consumers. The area outlined in green is
equal to the revenue the government collects from the tax. Consumer and producer surplus
fall by more than the revenue collected by the government. The deadweight loss
due to the tax is shown as the area outlined in red. Panel B repeats the analysis for a
good whose demand curve is relatively elastic. More of the burden of the tax falls on
producers, and the deadweight loss is larger.
Efficiency
In the basic competitive model, with each consumer and each firm taking the market
price as given, the equilibrium between demand and supply ensures the largest possible
joint gain to consumers and firms. This is why most economists believe that
the basic competitive model provides an important benchmark for evaluating how
well resources are allocated. Taxes on specific goods create efficiency losses, as does
interfering with the law of supply and demand through policies such as rent control.
These policies may have desirable effects (a tax on cigarettes helps to reduce
smoking, for instance), but those effects must be balanced against the inefficiencies
they create. As we have seen before, trade-offs must be made.
If the conditions of the basic competitive model are satisfied, markets do a good
job of allocating society’s resources efficiently. But the benchmark provided by the
basic competitive model is also useful because it helps us understand how markets
can fail when the basic assumptions of the model do not hold. In Part Three, we consider
a number of factors that cause markets to be inefficient. But first, we need to
examine more closely what economists mean when they talk about the efficiency
of markets.
EFFICIENCY ∂ 221