WHAT IS MEANT BY A TAX?

A lot of people get confused when they study taxes. So in this post i will be explaining taxes.

TAX

Tax is an important policy instrument usually imposed by the government either on buyers or on sellers.

First we will deal the tax on buyers. If the tax will be on buyers the demand curve will shift to the left in a magnitude which is equal to the tax i.e the vertical distance between the old and new demand curve will be equal to the tax
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• In the figure you can see that when there was no tax imposed the equilibrium quantity and equilibrium price were Q1 and P1 respectively.

• But when the tax is imposed the demand curve shifts to the left (not shown in the diagram) and new equilibrium price and quantity are Q2 and P2 respectively.

• But P2 is the price received by the sellers as it is the lower price whereas we can calculate the price paid by the buyers can be calculated by extending a vertical line to the original demand curve. This will give us the price paid by the buyers which is P3.

• Now let us consider that the tax on the sellers then the supply curve will shift to the left to a distance equal to the tax and now the new equilibrium price and quantity will be P3 and Q2.

• Here P3 is the price paid by the buyers. To find the price received by the sellers we will draw a vertical line from new equilibrium point to the original supply curve. And so the price received by the sellers is P2.

• You must have noticed that whether the tax is on buyers or on sellers the price paid by the buyers is always greater than the price received by the sellers.

• This is because a tax distorts the market in such a way that both buyers and sellers are worse off

• Now let's talk about the tax in terms of surplus

• Before the tax the consumer surplus was A+B+C but after the tax it was A

• Before the tax the producer surplus was D+E+F but after the tax it was F

• Now you must be wondering what happened to B+C+D+E

• When government imposes a tax it gets revenue which can be calculated by multiplying the quantity after the tax with the magnitude of the tax. i.e. B+D

• And C+E is the dead weight loss. What is meant by a deadweight loss? It the loss of surplus that results from tax.