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Taxation and Government Intervention


Learning Objectives

AFTER READING THIS CHAPTER, YOU SHOULD BE ABLE TO:

  1. Show how equilibrium maximizes producer and consumer surplus.


  2. Demonstrate the burden of taxation to consumers and producers.


  3. Explain why the person who physically pays the tax is not necessarily the person who bears the burden of the tax.


  4. Demonstrate how an effective price ceiling is the equivalent of a tax on producers and a subsidy to consumers.


  5. Define rent seeking and show how it is related to elasticity.


  6. State the general rule of political economy.

Chapter Summary

This chapter introduces consumer and producer surplus. Consumer surplus is the difference between what buyers would be willing to pay and what they actually have to pay. Producer surplus is the difference between what sellers would be willing to accept and what they actually receive as payment.

This chapter also examines the burden of taxation. We find that the person who physically pays a tax is not necessarily the person who bears the burden of the tax. Who bears the burden largely depends on elasticities of demand and supply. A price ceiling is in essence an implicit tax on producers and an implicit subsidy to consumers. Conversely, a price floor is in essence an implicit tax on consumers and an implicit subsidy to producers. This chapter concludes by investigating rent-seeking behavior, which is comprised of activities designed to transfer surplus from one group to another. The general rule of political economy tells us that policies tend to reflect small groups' interests, not the interests of large groups.

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