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♪ [music] ♪

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- [Tyler] Today we begin
the first of several talks

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on taxes and subsidies.

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We're not going to be talking
about income taxes

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and income subsidies.

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Those are typically topics
for macroeconomics.

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Instead, we'll be talking
about taxes and subsidies on goods,

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like a sales tax
or a subsidy for wheat.

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These are also called
commodity taxes and subsidies.

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So let's get going.

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We're going to be emphasizing
three important ideas

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about commodity taxation.

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First, who pays the tax
does not depend

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on who writes the check
to the government.

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For example, suppose the government
is taxing apples.

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The government could make
the buyer of apples

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pay for each apple that they buy.

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Or they could require the sellers
of the apples pay for each apple

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that they sell.

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What we're going to show is that,
from the point of view

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of the buyers or sellers,
it actually doesn't matter

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how the tax is placed.

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The actual outcomes
are going to be identical.

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Another way of putting this
is that the economic incidence

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of the tax, who actually pays
the tax, does not depend

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on the legal incidence,
who is in law required to write

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the check to the government.

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This will become a little bit
clearer as we go along.

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Don't worry about it
if it's not clear yet.

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The second key point,
who pays the tax

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does depend on the relative
elasticities of demand and supply.

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In fact, we can summarize
point one and point two by saying,

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who pays the tax depends not
on the laws of congress

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but rather on the laws
of supply and demand.

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The third point
is that commodity taxation

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raises revenue,
but it also takes away

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some gains from trade, that is,
it creates deadweight loss.

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We're going to be looking
at point one in this talk,

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and then we'll move on
to point two, and point three

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in later talks.

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So, let's start with point one.

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Let's begin our analysis
of commodity taxation

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by assuming the suppliers
are the one who have to send

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the check to the government.

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That is, the legal incidence
of the tax falls on the suppliers.

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What does a tax
on the suppliers do?

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We can think about a tax
on suppliers

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as increasing their costs.

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This is going to shift
the supply curve up

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by the amount of the tax,
so the supply curve

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shifts up like this.

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Another way of thinking
about this, is to remember

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that the supply curve tells us
the minimum amount

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which suppliers require to offer
a given quantity

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in the marketplace.

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The tax, that is going to increase
the minimum amount that suppliers

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are requiring to offer
that quantity in the marketplace.

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It shifts up that minimum amount
required by just the amount

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of the tax.

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With the new supply curve
we find the new equilibrium.

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The market equilibrium
moves from point A to point B.

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What we see is that of course,
the quantity which is exchanged

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goes down, in addition,
the price paid

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by the buyers goes up.

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How much do the suppliers get?

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The suppliers collect this amount,
the price paid by the buyers,

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but now they have to give
a certain amount of that,

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the tax to the government.

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The suppliers end up receiving
this amount after tax, right here.

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In other words, what the tax does,
it means that the buyers

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pay more than before,
and the sellers receive

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less than before.

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Without any tax,
the price the buyers pay

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is the same as the price
the supplier receives.

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With the tax,
the buyers pay a certain price,

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but the sellers get less than that.

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They get whatever the buyers pay
minus of course, the tax.

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That's the situation
when the suppliers pay the tax,

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or the suppliers have to send
the check to the government.

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Let's now look at what happens
when it's the buyers

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who must send the check
to the government.

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Now, we look at the situation
when the legal incidence

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is on the buyers.

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We begin just as before
with the equilibrium with no taxes.

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No taxes on sellers or buyers.

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Again, that equilibrium
is at point A.

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I've also included
this supply curve here.

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This is the supply curve
when the tax is on the suppliers.

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It's the supply curve
from the previous problem.

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It's not relevant for this problem.

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I've included it rather
to remind us of where

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the equilibrium
on the previous problem was.

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You can think of this
as a kind of ghost supply curve.

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It's a supply curve
from the previous problem

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coming back to haunt us.

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So what's the effect
of a tax on the demanders?

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Think about it this way.

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Suppose the most you were willing
to pay for an apple is $1.

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Again, most you're willing to pay
for that apple, a dollar, no more.

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Now, suppose you learned
that the government has instituted

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a new tax.

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For every apple you buy,
you must now pay 25 cents

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to the government.

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Now, how much
are you willing to pay

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to suppliers for that apple?

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You're only willing to pay
the maximum amount

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that you're going to be willing
to pay suppliers

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is now 75 cents.

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The maximum amount
that apple was worth to you

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is a dollar.

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If you know you're going
to be taxed 25 cents

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if you buy that apple,

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then the most you're going
to be willing to pay the supplier

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is 75 cents, because 75 cents
plus the 25 cent tax

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to the government, that's $1.

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That's the most you're willing
to pay to get the apple.

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In other words, what a tax
on demanders does

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is it reduces
their willingness to pay,

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and that means
the demand curve shifts.

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Which way? The demand curve shifts
down by the amount of the tax.

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So let's shift.

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The tax is exactly
the same amount that it was before.

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Let's shift the demand curve
down by the amount of the tax.

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We find now
that the new equilibrium

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is at point B.

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Notice first of all,
that the quantity has declined.

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The quantity exchange has declined
by exactly the same amount

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as before in the previous problem.

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What about the price
received by the sellers?

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The sellers now receive this price.

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Lo and behold,
that's exactly the same price

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as it was before.

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How about the price
paid by the buyers?

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The buyers now pay
what they paid to the suppliers,

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plus they must pay the tax
to the government.

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This distance is the tax.

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Lo and behold, the price after tax
paid by the buyers

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is once again exactly
what it was when the tax

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was on the suppliers.

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When the tax is on the buyers,
the buyers pay more than before.

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The sellers receive less
than before

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by exactly the same amounts.

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The quantity declines
by the same amount, too.

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The net price,
or the total price paid

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by the buyers is the same.

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The total price received
by the sellers is the same.

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Now that you know the idea,
I'm going to show you a simpler way

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of demonstrating this.

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What we just showed
is that it doesn't matter

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whether the suppliers
must write the check

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to the government, or the demanders
must write the check

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to the government
in order to pay the tax.

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In other words,
we can analyze the tax

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by shifting the supply curve up,
or by shifting

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the demand curve down.

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As long as we analyze
the same size tax,

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we're going to get
equivalent outcomes.

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It's going to come out the same
whichever choice of tax we make.

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There's actually a simpler way
of thinking about this.

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What we can think
about such a tax is doing,

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is driving a wedge
between what the buyer is paying

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and what the sellers receive.

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When there's no tax,
what the buyers pay

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is what the sellers receive,
but when there's a tax,

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the buyers pay more
than what the sellers receive.

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The difference
is what the government gets.

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The difference
is the amount of the tax.

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So let's think about this
as a tax wedge.

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Let's say this tax wedge,
this side is, let's say a dollar.

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Another way of analyzing
the tax is to drive this wedge

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into the diagram
until the top of the wedge

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hits the demand curve,
and the bottom of the wedge

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just touches the supply curve.

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Let's take a look.

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I'm going to drive the wedge in.

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What this tells us
is that the price the buyer pays

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will be here, point B.

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The price the suppliers receive
will be point D.

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The difference is the tax.

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For instance, if the buyers
end up paying $2.65,

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then the sellers must receive $1.65
if the tax is a dollar.

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Similarly, if the suppliers receive
a $1.65 and the tax is a dollar,

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the buyers must be paying $2.65.

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With this wedge, we could read
off the diagram

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the price the buyer pays,
the price the seller receives,

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and the quantity exchanged.

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We don't even have
to shift any curves.

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We just drive the wedge
into this diagram.

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Let's do an application.

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In the United States,

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under the Federal Insurance
Contributions Act -- FICA --

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12.4% of earned income
up to an annual limit

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must be paid into social security,
and 2.9%, an additional 2.9%

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must be paid into Medicare.

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Half of this amount comes directly
from the employee.

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You can see it
on your own paychecks.

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This is the FICA tax,
and half the amount comes

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from the employer.

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The question is, does the fact
that it's a 50/50 split,

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does this make a difference?

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Does this mean for example,
that since the employer

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is paying half that this is necessarily
a good deal for the employee?

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No, it doesn't mean that.

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What we now know
is that we could have 100%

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of this tax paid by the employee,
or we could have 100%

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of this tax paid by the employer.

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This wouldn't make a difference,
not to wages, not to prices,

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not to anything.

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It would change
the legal incidence of the tax,

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but it would not change
the final economic incidence.

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I haven't said here
who actually pays the tax.

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That's what we're going
to be talking about

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in the next lecture.

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What I've said here
is that it doesn't matter

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who pays the tax
from a legal point-of-view

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of who is obliged
to deliver that money.

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So the legal incidence again,
does not have a bearing

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on the economic incidence
of the tax.

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What we're going to talk
about in the next lecture

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is what does determine
the economic incidence of a tax.

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It turns out to be elasticities
of supply and demand,

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and that's what we'll take up
in the next lecture.

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Thanks again for listening.

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- [Narrator] If you want
to test yourself,

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click "Practice Questions."

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Or if you're ready to move on,
just click "Next Video."

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♪ [music] ♪