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The Effects of a Per Unit Tax - Inelastic Demand - YouTube
Channel: Jason Welker
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in today's video lecture we're going to
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be talking about the effects of an
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excise tax on a particular good or
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service let's begin by defining an
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excise tax an excise tax is defined as a
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specific or an ad valorem tax placed by
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the government on a particular good or
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service so this raises the question what
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is the difference between a specific
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excise tax and an ad valorem excise tax
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let's distinguish between these two
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different types of excise tax now a
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specific tax is basically a tax of a
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specific amount paid on every unit of a
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product sold an example of this is a
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$2.00 tax on each pack of cigarettes in
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contrast an ad valorem tax is another
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type of excise excise tax that is based
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on a particular percentage of the sales
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price of a product for instance a 50
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percent tax on a pack of cigarettes
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would be considered an ad valorem tax
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this differs from an excise tax in that
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it is not always the same dollar amount
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rather it is based on a percentage of
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the sales price and the graph on the
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right we're going to be examining the
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impact of a specific tax on the market
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for cigarettes in other words we'll be
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looking at what happens to the market
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for cigarettes if the government is to
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place a $2.00 tax per pack of cigarettes
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looking at the graph on the right we
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have the demand for cigarettes and the
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supply of cigarettes we can see the
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demand is downward sloping supply of
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course is upward sloping without any
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government intervention at all the
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equilibrium price of cigarettes will be
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$5 and the equilibrium quantity of
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cigarettes sold will be 30,000 packs of
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cigarettes now what will happen when
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there is a $2.00 tax on each pack of
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cigarettes sold remember from previous
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units that the Mart that the supply
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curve for a good like cigarettes
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represents the marginal cost curve
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therefore any tax on cigarettes will
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essentially increase the marginal cost
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of providing cigarettes since the tax
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ultimately must be paid by cigarette
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producers we can view the effect of a
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$2.00 tax
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as an upward shift of the marginal cost
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curve by two dollars in essence a tax of
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two dollars per pack of cigarettes means
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that cigarette producers now face an
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additional cost of two dollars for every
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pack of cigarettes they sell the impact
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that this will have on the market for
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cigarettes will be seen as an increase
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in the marginal cost of cigarettes or
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another way of saying that is a decrease
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in the supply of cigarettes and since we
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notice the tax is two dollars we know
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that this supply curve will shift
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upwards by an amount of two dollars all
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we have to do now is connect these dots
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and we should see our new supply of
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cigarettes curve as can be seen the
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supply of cigarettes has decreased due
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to the tax on cigarettes another way of
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seeing this is that the marginal cost of
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cigarettes has increased by two dollars
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at every quantity so the vertical
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distance between the original supply
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curve and the new supply curve
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represents the actual amount of the tax
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we can call this new supply curve supply
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with tax now let's examine the impact
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that this $2 tax on each pack of
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cigarettes has on the equilibrium
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quantity and the equilibrium price of
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cigarettes and we'll examine who bears
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most of the burden of this $2 tax
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whether consumers or producers bear most
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of the burden depends on the
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responsiveness of producers and
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consumers to this $2 tax first let's see
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how the $2 tax affects the quantity
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demanded and the price of cigarettes at
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first instinct it might appear that a
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two dollar tax on each pack of
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cigarettes will raise the price of
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cigarettes by two dollars for consumers
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however once we look at our diagram we
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can see that this is not necessarily the
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case first of all the tax leads to a
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decrease in the quantity demanded this
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makes sense because clearly the price is
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higher than it was before however what
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we also notice is that the price of
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cigarettes does not increase by the full
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two dollars of the tax in fact our new
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equilibrium price is somewhere between
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six and seven dollars on this graph
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whereas the original equilibrium price
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was five dollars you would think that
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with the $2 tax the price of cigarettes
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might raise
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six dollars but this is not the case
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let's explain why the decrease in the
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supply leads to an increase in the price
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and a decrease in the quantity demanded
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however the price does not increase by
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the full two dollars this is because
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consumers demand for cigarettes is not
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perfectly in elastic if it were if
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consumers were totally unresponsive to
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changes in the price of cigarettes then
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it's highly likely that the producers of
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cigarettes would simply raise the price
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of each pack by two dollars leading to
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no decrease in the quantity demanded
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however clearly the demand for
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cigarettes is downward sloping
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therefore consumers are somewhat
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responsive to the change in price of
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cigarettes producers would find that if
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they were to raise the price of
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cigarettes by the full two dollars then
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the quantity demanded would fall so much
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that the producers of cigarettes would
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suffer unnecessarily
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therefore they only raise the price by
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according to our graph here around one
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dollar and twenty cents as we can see
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here on the other hand the the 80 cents
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that still must be paid towards the tax
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comes out of the pockets of producers we
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can see that producers ultimately accept
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a lower price for the cigarettes of
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around four dollars and 20 cents so we
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can see here that the new equilibrium
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price of six dollars is about two
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dollars more than the price that
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producers ultimately get to keep which
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is somewhere above four dollars so what
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we see is that the price that consumers
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pay of just over six dollars minus the
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$2.00 tax tells us the price that
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producers of cigarettes get to keep now
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we see that the price has increased but
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not by the full two dollars but the
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price that consumers pay includes part
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of the $2 tax the price that producers
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keep subtracts some of that $2 tax
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therefore the tax burden is shared
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between producers and consumers tax
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burden refers to the amount of the tax
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paid by producers and the amount of the
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tax paid by consumers the area move up
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to shade in blue the area above the old
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price of $5 and below the new price of
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around 6.20 cents represents the amount
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of this tax or the share of this $2 tax
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paid by consumers of cigarettes the area
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I'm shading in green represents the tax
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burden
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of the producers of cigarettes we see
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that since producers had to accept a
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lower price for their packs of
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cigarettes they share some of the burden
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of the tax
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also since consumers have to pay a
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higher price they share some of the
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burden of the tax I've called the blue
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rectangle CB for consumer burden and the
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green rectangle PB for producer burden
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as we can see here the increase in the
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price that consumers pay is greater than
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the decrease in the price that producers
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get to keep this means that the
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consumers they're a larger burden of the
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tax on cigarettes than producers do
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another way of saying that is that the
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blue rectangle here is larger than the
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green rectangle indicating that the
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consumer tax burden is greater than the
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producer tax burden the next thing we
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want to look at is the net effect on
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total welfare by which we mean consumer
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and producers surplus in the market for
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cigarettes as can be seen before the tax
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was imposed the original price of
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cigarettes was only $5 and the original
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quantity was 30000 packs of cigarettes
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now that the price is higher around six
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dollars and 20 cents the quantity of
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cigarettes demanded is lower only twenty
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five thousand cigarettes or just below
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25,000 in addition consumers pay a
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higher price therefore there is less
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consumer surplus than there was before
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the area I'm shading in purple
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represents the consumer surplus after
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the tax before the tax of course the
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consumer surplus would have been a much
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larger triangle since consumers enjoyed
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a lower price and enjoyed a greater
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quantity of cigarettes the purple
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triangle here represents consumer
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surplus after the $2 tax on cigarettes
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does this necessarily mean that
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producers are better off since consumers
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are worse off in fact producers of
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cigarettes are also worse off because of
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the tax the reason for this is that they
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get to keep a lower price now than they
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did before whereas before the tax
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producers were receiving $5.00 per pack
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after the tax producers are receiving
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just over $4 per pack so the area of
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producer surplus is now smaller than it
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was before below 4 dollars and 20 cents
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above the price intercept of $1 and
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above the supply curve so the yellow
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triangle here represents producer
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surplus following the tax we've got
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consumer surplus after the tax we've got
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producer surplus after the tax and this
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leaves one small area that used to be
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community surplus or total welfare
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before the tax was imposed but it's but
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is now no longer enjoyed by producers or
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consumers this little triangle on the
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right here which I am outlining in black
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represents the loss of welfare resulting
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from the tax in economics we refer to
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this as the dead weight loss of the tax
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because this tax led to higher prices
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for consumers and lower prices for
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producers the overall welfare among
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consumers and producers in the market
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for cigarettes is less than it was
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before but this raises one question why
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if the consumer tax burden and the
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producer tax burden are losses of
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welfare to consumers and producers are
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these not considered deadweight loss the
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reason for that is that this $2 right
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here actually goes to government it's
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not a loss of welfare this will go to
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the government which it can then be used
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for the provision of public goods and
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services such as health education or
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public schools or for infrastructure
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projects therefore the sum of the
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consumer tax burden and the producer tax
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burden which is the rectangle I'm
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outlining in red represents tax revenue
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for the government resulting from the
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tax on cigarettes so the red rectangle
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here represents government tax revenue
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it is not deadweight loss because the
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government enjoys this income that it
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raises from the tax on cigarettes
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however there is a net loss of total
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welfare among smokers and cigarette
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producers equal to the black triangle
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here we can see that the $2 tox and
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cigarettes reduce the quantity supplied
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and demanded in the market for
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cigarettes from around 30,000 packs to
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just below 25
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thousand packs we can also see that it
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raised the price that consumers pay for
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cigarettes from five dollars to just
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over six dollars this one dollar and
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twenty cents cent increase did not
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encompass the full two dollars of the
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tax because producers share part of that
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tax burden by accepting a lower price
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when they've paid the tax to the
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government here we see that a specific
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excise tax of two dollars per pack of
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cigarettes is shared by the consumers of
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cigarettes and the producers of
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cigarettes the decrease in the supply of
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cigarettes corresponds with an increase
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in the marginal cost
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- cigarette producers resulting from the
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fact that they have to now pay a $2.00
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tax to government for every pack however
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since the demand for cigarettes is
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relatively inelastic and we'll explore
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this more in our next video podcast the
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consumers of cigarettes end up sharing a
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larger burden of this tax than the
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producers of cigarettes they are
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relatively unresponsive to increases in
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the price of cigarettes therefore the
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producers pass most of the tax around
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one dollar and twenty cents of it on to
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the consumers rather than paying the
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full two dollar tax themselves producers
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only pay about 80 cents of this tax
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consumers pay a dollar and 20 cents of
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this tax they're for consumers bear a
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larger burden of the tax in the next
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video we're going to talk about how a
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tax on a good for which demand is
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relatively elastic will ultimately be
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borne more by producers than by
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consumers
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