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Social Science Clinic => Economics => Macroeconomics => Topic started by: warrenjean01 on Nov 23, 2022

Title: The graphs show the supply (S) and demand (D) in the market for labor that has a tax on labor ...
Post by: warrenjean01 on Nov 23, 2022

The graphs show the supply (S) and demand (D) in the market for labor that has a tax on labor income, in the market for capital that has a tax on capital income, and in the market for land that has a tax on land income.



Assume that P1=$12.50, P2=$24.00, P3=$36.50, Q1=$320, Q2=785, and Q3=1,130. Which tax is most efficient? Which is the least efficient?
◦ labor tax, land tax
◦ capital tax, labor tax
◦ capital tax, land tax
◦ land tax, capital tax

Title: The graphs show the supply (S) and demand (D) in the market for labor that has a tax on labor ...
Post by: wangyichun on Nov 23, 2022

land tax, capital tax

The tax that is most efficient is the one that creates the smallest deadweight loss.

Labor market
Before the tax, market equilibrium occurs where supply (S) equals demand (D), at a price of P1 = $12.50 and a quantity of Q3 = 1,130.
After the tax, market equilibrium occurs where supply with the tax (S_tax) equals demand (D), at a price of P2 = $24.00 and a quantity of Q2 = 785.
Deadweight loss is the shaded triangle in the graph:

Deadweight loss = 0.5 * base * height
In this case, the supply curve is shifted by an equal amount, so the height = P3 - P1 = 36.50 - 12.50 = $24 = tax
Deadweight loss = 0.5*(Q3 - Q2)*(P3 - P1) = 0.5*(1,130-785)*(24) = $4,140.00

Capital market
Before the tax, market equilibrium occurs where supply (S) equals demand (D), at a price of P1 = $12.50 and a quantity of Q3 = 1,130.
After the tax, market equilibrium occurs where supply with the tax (S_tax) equals demand (D), at a price of P3 = $36.50 and a quantity of Q1 = 320.
Deadweight loss is the shaded triangle in the graph:

Deadweight loss = 0.5 * base * height = 0.5*(Q3 - Q1)*(P3 - P1) = 0.5*(1,130-320)*(36.50-12.50) = $9,720.00

Land market
Before the tax, market equilibrium occurs where supply (S) equals demand (D), at a price of P3 = $36.50 and a quantity of Q2 = 785.
Because the supply of land is fixed, after the tax, market equilibrium occurs at the same spot.
In the land market, there is no deadweight loss due to the tax.

Deadweight loss in labor market = $4,140.00
Deadweight loss in capital market = $9,720.00
Deadweight loss in land market = $0
Therefore, the most efficient tax is the tax on land and the least efficient tax is the tax on capital.