AP Micro taxes and deadweight loss cheat sheet

What is a tax?

A mandatory financial charge imposed by the government to fund public services.

Define tax base.

The total amount of assets or income that can be taxed, such as income, sales, or property.

True or False: All taxes are proportional.

False. Taxes can be progressive, regressive, or proportional based on income levels.

What is a progressive tax?

A tax in which the tax rate increases as the taxable amount increases, e.g., income tax.

Fill in the blank: A ____ tax takes a larger percentage from high-income earners than low-income earners.

progressive

Describe a regressive tax.

A tax that takes a larger percentage of income from low-income earners than from high-income earners.

What is a flat tax?

A tax system with a constant tax rate, regardless of income level, e.g., a single sales tax rate.

Tax revenue formula.

Tax Revenue = Tax Rate × Tax Base.

True or False: Deadweight loss occurs only with sales taxes.

False. Deadweight loss can result from any distortionary tax.

What is tax incidence?

The distribution of the tax burden between buyers and sellers in a market.

Cause → Effect: High taxes on goods...

...lead to decreased quantity demanded and potential black markets.

Example of tax burden.

If a $\displaystyle 2 tax is placed on a product, consumers may pay$1.50 more, while producers receive $0.50 less.

What does elasticity of demand indicate for tax incidence?

More elastic demand means consumers bear less tax burden; less elastic means they bear more.

Differentiate between direct and indirect taxes.

Direct taxes are levied on income (e.g., income tax); indirect taxes are imposed on goods/services (e.g., sales tax).

What is a payroll tax?

A tax imposed on wages to fund social security and Medicare programs.

What is an excise tax?

A tax on specific goods, such as gasoline or tobacco, intended to discourage consumption.

What is deadweight loss?

Deadweight loss refers to the loss of economic efficiency when the equilibrium outcome is not achievable or not achieved.

Causes of deadweight loss?

- Taxes - Price controls - Monopolies - Externalities

True or False: Deadweight loss increases consumer and producer surplus.

False. Deadweight loss decreases overall surplus, leading to inefficiency.

Fill in the blank: Deadweight loss occurs when _______ is not maximized.

total welfare

How does a tax create deadweight loss?

A tax raises prices, discouraging consumption and production, thus reducing quantity traded below equilibrium.

Difference between consumer surplus and producer surplus?

Consumer surplus is the benefit consumers receive, while producer surplus is the benefit producers receive from selling.

Graphically, deadweight loss is represented by _______.

the triangle formed between the supply and demand curves at quantities different from equilibrium.

Calculate deadweight loss: Tax increases price from $\displaystyle 10 to$12, reducing quantity from 100 to 90.

DWL = 0.5 * (Tax) * (Reduction in quantity) = 0.5 * (2) * (10) = $10.

Identify this implication: Deadweight loss reduces _______.

overall economic efficiency

True or False: Deadweight loss only occurs with taxes.

False. Deadweight loss can occur due to price ceilings, price floors, and monopolies.

What happens to deadweight loss in a perfectly competitive market?

In a perfectly competitive market, deadweight loss is minimized, as the market naturally reaches equilibrium.

Cause → Effect: Price ceiling → _______.

Potential deadweight loss due to reduced supply.

What is the impact of subsidies on deadweight loss?

Subsidies can also create deadweight loss by distorting market prices and encouraging overproduction.

Identify one way to reduce deadweight loss.

Eliminate or reduce taxes, or improve market efficiency.

What does the deadweight loss triangle represent?

The loss of economic efficiency due to the reduced quantity traded.

Effect of monopoly pricing on deadweight loss?

Monopoly pricing leads to higher prices and less quantity compared to perfect competition, creating deadweight loss.

Tax Incidence

The distribution of tax burden between consumers and producers. Depends on price elasticity.

True or False: Consumers always bear more tax burden than producers.

False. The incidence depends on the elasticity of demand and supply.

Price Elasticity of Demand

A measure of how much the quantity demanded responds to a change in price. More elastic means consumers bear less tax burden.

Formula for Tax Incidence

Tax burden on consumers = (Elasticity of supply) / (Elasticity of demand + Elasticity of supply)

Fill in the blank: The more elastic the demand, the greater the __________.

Tax burden on producers.

Effect of a Tax Increase

Increases prices for consumers, decreases quantity supplied, and may reduce consumer surplus.

Example: Tax on Cigarettes

A $\displaystyle 2 tax per pack might lead to a$1.50 price increase for consumers, with producers absorbing $0.50.

True or False: Tax revenue is always higher with inelastic demand.

True. Inelastic demand leads to less reduction in quantity sold, thus higher revenue.

Comparison: Elastic vs. Inelastic Demand

Elastic: consumers change quantity greatly with price changes. Inelastic: quantity changes little.

Effect on Producer Surplus

Taxes can decrease producer surplus by raising costs and lowering effective price received.

Consumer Burden in Elastic Demand

Consumers bear a smaller tax burden when the demand is elastic because they can find substitutes.

Supply Elasticity Impact

More elastic supply means producers can more easily change production, leading to less tax burden.

Graphical Representation of Tax Incidence

The tax wedge shows the difference between price consumers pay and price producers receive.

Deadweight Loss from Taxation

Occurs when tax reduces the quantity traded below the efficient level, leading to lost welfare.

Consumer Price Increase Example

If a tax raises the price of a good from $\displaystyle 5 to$6, consumers face a burden of $1.

Overall Tax Burden Equation

Tax burden = Price increase for consumers + Price decrease for producers.