Chapter 8: The Costs of Taxation

Chapter 8 discussed the costs of taxation. It goes back to what we discussed in Chapter 6, how taxes affect quantity sold and the burden of the tax. In this chapter it extends the analysis to how taxes affect welfare. Tax revenue is the size of the tax multiplied by the quantity sold. Deadweight loss is introduced in this chapter, and it is the fall in total surplus that results from a market distortion, such as a tax. It is the area between the supply and demand curves from the new quantity with tax to the equilibrium quantity without tax. When the supply or demand are inelastic, the deadweight loss is small. However when the supply or demand are elastic, the deadweight loss is large. Buyers and sellers will respond to a change in price more dramatically when it is elastic, so there would be more deadweight loss. The opposite can be said of inelastic goods. As the size of the tax increases, the deadweight loss also increases but varies directly to the square of the tax size. As the size of the tax increases, tax revenue first increases but will decrease. This is because the revenue is the tax times the quantity sold, and if the quantity decreases past the point where tax times quantity is maximized, revenue decreases. This chapter was pretty easy to understand and connects back to what they've discussed in previous chapters, so I would give this chapter a 1 difficulty rating.