How A TAX AFFECTS MARKET PARTICIPANTS
Now let’s use the tools of welfare economics to measure the gains and losses from a tax on a good. To do this, we must take into account how the tax affects buyers, sellers, and the government. The benefit received by buyers in a market is measured by consumer surplus-the amount buyers are willing to pay for the good minus the amount they actually pay for it. The benefit received by sellers in a market is measured by producer surplus-the amount sellers receive for the good milieus their costs. These are precisely the
measures of economic welfare we used in Chapter 7. What about the third interested party, the government? If T is the size of the tax and Q is the quantity of he good sold, then the government gets total tax revenue of T X Q. It can use this tax revenue to provide services, such as roads, police, and public education, or to help the needy. There fore, to analyze how taxes affect economic well-being, we use tax r-e.venue to measure the government’s benefit from the tax. Keep i.n mind, however, that this benefit actually accrues not to government but to those on whom the revenue IS spent.
Figure 2 shows that the government’s tax revenue is represented by the rectangle between the supply and demand curves. The height of this rectangle is the size of the tax and the width of the rectangle is he quantity of the good sold, Q. Because a rectangle’s area is its height times its width, this rectangle’s area is T X Q, which equals the tax revenue.
figure 2 Tax Revenue The tax revenue that the government collects equals T x Q, the size of the tax T times the quantity sold Q Thus, tax revenue equals the area of the rectangle between the supply and demand curves.
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