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Title: 
[Events]
Format: Layer, Start, End, Style, Name, MarginL, MarginR, MarginV, Effect, Text
Dialogue: 0,0:00:02.26,0:00:04.74,Default,,0000,0000,0000,,♪ [music] ♪
Dialogue: 0,0:00:08.17,0:00:13.87,Default,,0000,0000,0000,,- So far in our videos, we've looked at\Nthe effect of taxes on market prices, but
Dialogue: 0,0:00:14.05,0:00:18.97,Default,,0000,0000,0000,,we haven't said much about why government\Nlevies taxes in the first place, namely to
Dialogue: 0,0:00:19.15,0:00:24.52,Default,,0000,0000,0000,,get revenues. So let's look at that and\Nalso the cost of raising revenues, which
Dialogue: 0,0:00:24.70,0:00:26.47,Default,,0000,0000,0000,,is deadweight loss.
Dialogue: 0,0:00:30.74,0:00:33.12,Default,,0000,0000,0000,,We can show pretty much\Neverything we need to show with a
Dialogue: 0,0:00:33.18,0:00:38.78,Default,,0000,0000,0000,,single diagram. So here is our initial\Nequilibrium. The price with no tax is $2
Dialogue: 0,0:00:38.96,0:00:46.26,Default,,0000,0000,0000,,and the quantity exchanged with no tax is\N700 units. Now, let's recall that consumer
Dialogue: 0,0:00:46.44,0:00:52.00,Default,,0000,0000,0000,,surplus is the consumer's gain from\Nexchange, and it's this green area here,
Dialogue: 0,0:00:52.18,0:00:57.56,Default,,0000,0000,0000,,the area underneath the demand curve and\Nabove the price, up to the quantity
Dialogue: 0,0:00:57.74,0:01:03.19,Default,,0000,0000,0000,,exchanged. So it's the area above the\Nprice of $2 and up to the quantity
Dialogue: 0,0:01:03.37,0:01:08.90,Default,,0000,0000,0000,,exchange of 700 below the demand curve,\Nthis area right here. Producer surplus is
Dialogue: 0,0:01:09.08,0:01:13.40,Default,,0000,0000,0000,,the producer's gain from exchange, and is\Nthe area above the supply curve, up to the
Dialogue: 0,0:01:13.58,0:01:19.27,Default,,0000,0000,0000,,quantity exchanged and below the price,\Nbelow the producer's price. Now, you may
Dialogue: 0,0:01:19.45,0:01:25.66,Default,,0000,0000,0000,,also recall that a free market maximizes\Nconsumer plus producer surplus. What we're
Dialogue: 0,0:01:25.84,0:01:29.64,Default,,0000,0000,0000,,going to show is that when we have a tax,\Nthis is no longer true. The intervention
Dialogue: 0,0:01:29.82,0:01:35.11,Default,,0000,0000,0000,,into the free market means that consumer\Nand producer surplus are not maximized.
Dialogue: 0,0:01:35.29,0:01:42.49,Default,,0000,0000,0000,,Let's take a look. So suppose we have tax\Nof $1, and using our wedge method, we can
Dialogue: 0,0:01:42.67,0:01:47.59,Default,,0000,0000,0000,,find what the new price is going to be for\Nthe buyers. It's going to be here. So the
Dialogue: 0,0:01:47.77,0:01:53.41,Default,,0000,0000,0000,,new price for the buyer is say, $2.50.\NNotice now, the consumer surplus is not
Dialogue: 0,0:01:53.59,0:01:59.33,Default,,0000,0000,0000,,this large green area since the price is\Nnow higher and the quantity exchanged has
Dialogue: 0,0:01:59.51,0:02:03.78,Default,,0000,0000,0000,,fallen.\NThe quantity exchanged falls from 700
Dialogue: 0,0:02:03.96,0:02:11.80,Default,,0000,0000,0000,,units to 500 units. So the consumer\Nsurplus with the tax is this smaller green
Dialogue: 0,0:02:11.98,0:02:17.95,Default,,0000,0000,0000,,area here. Again, it's the area above the\Nbuyer's price, up to the quantity
Dialogue: 0,0:02:18.13,0:02:23.88,Default,,0000,0000,0000,,exchanged, and below the demand. So\Nexactly the definition hasn't changed, but
Dialogue: 0,0:02:24.06,0:02:28.54,Default,,0000,0000,0000,,because of the tax, the price of the buyer\Nchanges, and the quantity demanded
Dialogue: 0,0:02:28.72,0:02:32.53,Default,,0000,0000,0000,,exchanges, so the consumer surplus changes\Nas well. In this case, it gets a lot
Dialogue: 0,0:02:32.71,0:02:39.07,Default,,0000,0000,0000,,smaller. What about producer surplus?\NWell, again, the price which the sellers
Dialogue: 0,0:02:39.25,0:02:45.30,Default,,0000,0000,0000,,receive falls. So producer surplus is no\Nlonger this large blue area, but is now
Dialogue: 0,0:02:45.48,0:02:52.08,Default,,0000,0000,0000,,just this much smaller blue area. So the\Ntax reduces consumer surplus and it
Dialogue: 0,0:02:52.26,0:02:56.52,Default,,0000,0000,0000,,reduces producer surplus. Now, what about\Nthis area in the middle? Well,
Dialogue: 0,0:02:56.70,0:03:02.18,Default,,0000,0000,0000,,fortunately, that's not wasted. That, in\Nfact, is tax revenues. So notice that the
Dialogue: 0,0:03:02.36,0:03:09.36,Default,,0000,0000,0000,,tax, the height of the tax here is $1 and\Nthere are 500 units exchanged, so the
Dialogue: 0,0:03:09.54,0:03:15.84,Default,,0000,0000,0000,,government gets $1 for each of those 500\Nunits. So this revenue, tax revenue is the
Dialogue: 0,0:03:15.84,0:03:22.82,Default,,0000,0000,0000,,area. It's the height of this box times\Nthe width, and the height is the tax, the
Dialogue: 0,0:03:22.82,0:03:28.40,Default,,0000,0000,0000,,width is the quantity exchanged. So this\Nis tax revenue. Now, what about this final
Dialogue: 0,0:03:28.50,0:03:34.32,Default,,0000,0000,0000,,bit over here? That used to be consumer\Nand producer surplus, but now it's
Dialogue: 0,0:03:34.32,0:03:41.100,Default,,0000,0000,0000,,deadweight loss. Nobody gets that. That is\Nlost gains from trade. So remember, people
Dialogue: 0,0:03:42.10,0:03:48.62,Default,,0000,0000,0000,,used to trade 700 units, now they're only\Ntrading 500 units. Those units were
Dialogue: 0,0:03:48.70,0:03:54.51,Default,,0000,0000,0000,,benefiting people, but they're not anymore\Nbecause these trades are not occurring.
Dialogue: 0,0:03:54.60,0:03:59.25,Default,,0000,0000,0000,,I'm going to explain that in a little bit\Nmore detail in the next slide. For now,
Dialogue: 0,0:03:59.40,0:04:03.70,Default,,0000,0000,0000,,just be sure that you understand how to\Nlabel these areas.
Dialogue: 0,0:04:03.88,0:04:09.73,Default,,0000,0000,0000,,So this is the new consumer surplus, tax\Nrevenues, the new producer surplus, and
Dialogue: 0,0:04:09.91,0:04:15.35,Default,,0000,0000,0000,,this area is deadweight loss. Okay, let's\Nexplain deadweight loss in a little bit
Dialogue: 0,0:04:15.53,0:04:19.90,Default,,0000,0000,0000,,more detail. Here's the way to think about\Ndeadweight loss. Suppose that you're
Dialogue: 0,0:04:20.08,0:04:23.67,Default,,0000,0000,0000,,planning a trip to New York and you're\Ngoing to take the bus. The benefit of the
Dialogue: 0,0:04:23.85,0:04:28.47,Default,,0000,0000,0000,,trip to you, the value of seeing the\Nsights in New York is $50, the cost of the
Dialogue: 0,0:04:28.65,0:04:30.21,Default,,0000,0000,0000,,bus ticket is $40.
Dialogue: 0,0:04:30.21,0:04:34.36,Default,,0000,0000,0000,,So do you take the trip?\NIs it a value? Yes, you take the trip. The
Dialogue: 0,0:04:34.36,0:04:39.40,Default,,0000,0000,0000,,total value of the trip is $10, it's a\Npositive, so you decide to take the trip.
Dialogue: 0,0:04:39.58,0:04:44.06,Default,,0000,0000,0000,,Trips is equal to one. You make the trip.\NOkay, no problem. Now, suppose there's a
Dialogue: 0,0:04:44.24,0:04:51.87,Default,,0000,0000,0000,,tax of $20 on bus fares and let's suppose\Nthat raises the cost of the trip from $40
Dialogue: 0,0:04:52.05,0:04:57.58,Default,,0000,0000,0000,,to $60. It doesn't have to raise it by\Nexactly that amount, by exactly the $20,
Dialogue: 0,0:04:57.76,0:05:03.53,Default,,0000,0000,0000,,but let's suppose it does. Okay, so the\Ncost of the trip is now $60. The benefit
Dialogue: 0,0:05:03.71,0:05:11.80,Default,,0000,0000,0000,,is still $50. So do you take the trip? No.\NThe benefit is less than the cost. So now,
Dialogue: 0,0:05:11.98,0:05:19.75,Default,,0000,0000,0000,,no trip. Trips are equal to zero. Does the\Ngovernment raise any revenue from you? No.
Dialogue: 0,0:05:19.93,0:05:25.01,Default,,0000,0000,0000,,Since you don't take the trip, the\Ngovernment makes no revenue. Is there a
Dialogue: 0,0:05:25.19,0:05:31.41,Default,,0000,0000,0000,,deadweight loss? Yes. You have lost the\Nvalue of the trip. You used to, when there
Dialogue: 0,0:05:31.59,0:05:36.16,Default,,0000,0000,0000,,was no tax, you took the trip, it was\Nworth $10, so the world was better off by
Dialogue: 0,0:05:36.34,0:05:42.37,Default,,0000,0000,0000,,that $10 of value. Now with the tax, you\Ndon't take the trip, so that $10 is a
Dialogue: 0,0:05:42.55,0:05:49.95,Default,,0000,0000,0000,,deadweight loss. It's gone. And notice\Nthat it's not made up for by revenue.
Dialogue: 0,0:05:50.13,0:05:58.70,Default,,0000,0000,0000,,There's no revenue. So deadweight loss is\Nthe value of the trips not made because of
Dialogue: 0,0:05:58.88,0:06:03.23,Default,,0000,0000,0000,,the tax, and there's no revenue on trips\Nwhich aren't made.
Dialogue: 0,0:06:03.41,0:06:07.95,Default,,0000,0000,0000,,Government only makes revenue on the trips\Nwhich continue to occur. So deadweight
Dialogue: 0,0:06:08.13,0:06:14.02,Default,,0000,0000,0000,,loss is the value of the trips not made\Nbecause of the tax. Now, to return this to
Dialogue: 0,0:06:14.20,0:06:19.53,Default,,0000,0000,0000,,a more general case, instead of trips,\Nlet's just replace that with trades.
Dialogue: 0,0:06:19.71,0:06:26.58,Default,,0000,0000,0000,,Deadweight loss is the value of the trades\Nnot made because of the tax. Very quickly,
Dialogue: 0,0:06:26.76,0:06:32.80,Default,,0000,0000,0000,,here's our diagram again. Before the tax,\Nthere were 700 trades. After the tax,
Dialogue: 0,0:06:32.98,0:06:40.38,Default,,0000,0000,0000,,there were 500 trades. So these are the\N200 trades which are not made because of
Dialogue: 0,0:06:40.56,0:06:47.05,Default,,0000,0000,0000,,the tax. And the value of those 200 trades\Noccurs because for these trades, the
Dialogue: 0,0:06:47.23,0:06:54.52,Default,,0000,0000,0000,,demanders value them more than it costs\Nthe suppliers to provide those trades. So
Dialogue: 0,0:06:54.70,0:06:59.12,Default,,0000,0000,0000,,the demanders value the trades as given by\Nthe demand curve, the height of the demand
Dialogue: 0,0:06:59.30,0:07:04.93,Default,,0000,0000,0000,,curve, the suppliers are willing to supply\Nthose trades, the cost to them is given by
Dialogue: 0,0:07:05.11,0:07:12.26,Default,,0000,0000,0000,,the height of the supply curve, so the\Nvalue, the value minus the cost, if you
Dialogue: 0,0:07:12.44,0:07:19.34,Default,,0000,0000,0000,,like, is given by this triangle. Because\Nthose trades no longer occur, that value
Dialogue: 0,0:07:19.52,0:07:24.51,Default,,0000,0000,0000,,is no longer produced, that's deadweight\Nloss, the value of the trades which don't
Dialogue: 0,0:07:24.69,0:07:30.18,Default,,0000,0000,0000,,occur because of the tax. Here's one more\Nimportant point about deadweight loss.
Dialogue: 0,0:07:30.36,0:07:35.21,Default,,0000,0000,0000,,Deadweight losses are larger the more\Nelastic the demand curve holding revenues
Dialogue: 0,0:07:35.39,0:07:41.47,Default,,0000,0000,0000,,constant. So for example, which of these\Ngoods would we more like to tax, the one
Dialogue: 0,0:07:41.65,0:07:46.46,Default,,0000,0000,0000,,on the left where the demand curve is\Nelastic or the one on the right where the
Dialogue: 0,0:07:46.64,0:07:52.18,Default,,0000,0000,0000,,demand curve is more inelastic? Notice\Nthat tax revenues are the same. So if we
Dialogue: 0,0:07:52.36,0:07:56.89,Default,,0000,0000,0000,,have a choice, which good do we wanna tax?\NWell, pretty clearly, we wanna tax the
Dialogue: 0,0:07:57.07,0:08:02.10,Default,,0000,0000,0000,,good with the inelastic demand because the\Ndeadweight losses, the lost gains from
Dialogue: 0,0:08:02.28,0:08:05.91,Default,,0000,0000,0000,,trade, are much smaller over here than\Nthey are over here.
Dialogue: 0,0:08:06.09,0:08:11.81,Default,,0000,0000,0000,,So the tax on the good with the elastic\Ndemand, it's creating a lot of waste in
Dialogue: 0,0:08:11.99,0:08:16.60,Default,,0000,0000,0000,,order to get this revenue. Over here, the\Ntax on the good with the inelastic demand,
Dialogue: 0,0:08:16.78,0:08:22.24,Default,,0000,0000,0000,,there's only a little bit of waste for the\Nsame amount of revenue. The intuition here
Dialogue: 0,0:08:22.42,0:08:28.85,Default,,0000,0000,0000,,is pretty simple. If the demand curve is\Ninelastic, then a tax won't deter many
Dialogue: 0,0:08:29.03,0:08:33.40,Default,,0000,0000,0000,,trades. And that's what we don't want. We\Ndon't want to deter a lot of trades
Dialogue: 0,0:08:33.58,0:08:40.83,Default,,0000,0000,0000,,because it's the lost gains from trade\Nwhich create the problem. We don't get any
Dialogue: 0,0:08:41.01,0:08:47.92,Default,,0000,0000,0000,,tax revenue when we deter a trade. There's\Nno tax revenue when you deter an exchange.
Dialogue: 0,0:08:48.10,0:08:53.06,Default,,0000,0000,0000,,So we want to make sure that we deter as\Nfew exchanges as possible and that will
Dialogue: 0,0:08:53.24,0:08:58.56,Default,,0000,0000,0000,,maximize our revenue compared to our loss.\NNow, sometimes economists are laughed at
Dialogue: 0,0:08:58.74,0:09:03.34,Default,,0000,0000,0000,,or derided because this implies, for\Nexample, that you ought to tax insulin, a
Dialogue: 0,0:09:03.52,0:09:08.59,Default,,0000,0000,0000,,good with a very inelastic demand. Now,\Nthere are many reasons for taxing some
Dialogue: 0,0:09:08.77,0:09:12.89,Default,,0000,0000,0000,,goods and not other goods, depending upon\Nwho uses the insulin, whether it's poor
Dialogue: 0,0:09:13.07,0:09:19.67,Default,,0000,0000,0000,,people or rich people or how important\Nhealth is and so forth. Nevertheless, as a
Dialogue: 0,0:09:19.85,0:09:25.47,Default,,0000,0000,0000,,general rule, it is better to tax goods\Nwith an inelastic demand than goods with
Dialogue: 0,0:09:25.65,0:09:31.03,Default,,0000,0000,0000,,an elastic demand. That's important, and\Nlet me give you an illustration of that.
Dialogue: 0,0:09:31.21,0:09:34.23,Default,,0000,0000,0000,,Here's something which you might think\Nwould be a good idea to tax, luxury
Dialogue: 0,0:09:34.41,0:09:38.28,Default,,0000,0000,0000,,yachts. They're only bought by the rich,\Nso you're not really harming people very
Dialogue: 0,0:09:38.46,0:09:44.44,Default,,0000,0000,0000,,much, right? Well, maybe so. However, in\N1990, the federal government actually
Dialogue: 0,0:09:44.62,0:09:49.86,Default,,0000,0000,0000,,applied a 10% luxury tax to many luxury\Ngoods, including pleasure boats or yachts
Dialogue: 0,0:09:50.04,0:09:56.56,Default,,0000,0000,0000,,with a sales price above $100,000, the\Nexpected tax revenue of $31 million. The
Dialogue: 0,0:09:56.74,0:10:02.00,Default,,0000,0000,0000,,reality, however, was quite different. The\Ntax revenues were only $16.6 million.
Dialogue: 0,0:10:02.18,0:10:08.22,Default,,0000,0000,0000,,That was because sales of yachts fell\Ntremendously. Perhaps the yacht buyers
Dialogue: 0,0:10:08.40,0:10:11.66,Default,,0000,0000,0000,,decided, well, they could wait a year or\Ntwo before buying their yacht, see what
Dialogue: 0,0:10:11.84,0:10:16.03,Default,,0000,0000,0000,,happens, or maybe they decided they could\Nbuy their yachts in other countries.
Dialogue: 0,0:10:16.21,0:10:20.44,Default,,0000,0000,0000,,Yachts are pretty easy to move around the\Nworld. After all, that's what they're for.
Dialogue: 0,0:10:20.62,0:10:27.47,Default,,0000,0000,0000,,The net result, in fact, was a loss of\N7,000 jobs in the yacht industry. Indeed,
Dialogue: 0,0:10:27.65,0:10:32.32,Default,,0000,0000,0000,,the federal government ended up paying\Nout more in unemployment benefits to
Dialogue: 0,0:10:32.50,0:10:39.79,Default,,0000,0000,0000,,unemployed yacht workers than it collected\Nin tax revenues from yachts. Because of
Dialogue: 0,0:10:39.97,0:10:45.86,Default,,0000,0000,0000,,this, the federal tax was repealed in\N1993. The lesson here, don't tax goods
Dialogue: 0,0:10:46.04,0:10:50.09,Default,,0000,0000,0000,,which have really elastic demands.\NYou're not going to get a lot of revenue,
Dialogue: 0,0:10:50.27,0:10:54.44,Default,,0000,0000,0000,,you're going to deter a lot of trades, and\Nthat will create a lot of deadweight loss,
Dialogue: 0,0:10:54.62,0:10:59.23,Default,,0000,0000,0000,,and perhaps, secondary losses for other\Npeople, such as the workers. That's it
Dialogue: 0,0:10:59.41,0:11:04.43,Default,,0000,0000,0000,,actually for taxes. The only thing we have\Nleft to do is subsidies. We can actually
Dialogue: 0,0:11:04.61,0:11:09.19,Default,,0000,0000,0000,,do that in the next lecture pretty quickly\Nbecause subsidies are just negative taxes.
Dialogue: 0,0:11:09.37,0:11:14.22,Default,,0000,0000,0000,,So everything we've said about taxes, with\Njust a few changes to our language, will
Dialogue: 0,0:11:14.40,0:11:16.65,Default,,0000,0000,0000,,go through with subsidies as well. Thanks.
Dialogue: 0,0:11:16.83,0:11:22.89,Default,,0000,0000,0000,,- If you want to test yourself, click\NPractice Questions. Or if you're ready
Dialogue: 0,0:11:23.07,0:11:25.78,Default,,0000,0000,0000,,to move on, just click Next Video.
Dialogue: 0,0:11:26.30,0:11:28.40,Default,,0000,0000,0000,,♪ [music] ♪