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Taxes and perfectly elastic demand

AP.MICRO:
POL‑1 (EU)
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POL‑1.A (LO)
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POL‑1.A.5 (EK)
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POL‑1.A.6 (EK)
An interesting case of taxes and tax incidence is when one of the curves is perfectly elastic. Explore what happens when demand is perfectly elastic in this video. Created by Sal Khan.

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  • leaf green style avatar for user Grace Poulter
    Just want to clear it up. For a perfectly elastic curve there is no consumer surplus, is that right?
    (5 votes)
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  • aqualine ultimate style avatar for user http://facebookid.khanacademy.org/1045212471
    My question is regarding the last couple of videos. I am still a little confused about the concept of "perceived supply curve by consumers" once a tax is placed. What does that mean exactly, considering neither the curves actually shift?

    Also, I want to make sure I've understood the dynamics of bearing the tax burden. The tax will affect the final price directly, right? Once the tax is placed, quantity demanded will decrease according to demand elasticity, so the only consumers buying the product will be the ones willing to pay the price + tax, am I right? So in this case, the tax will lead to loss of potential consumers. Can this loss be seen in terms of deadweight loss?

    Regarding producers, the tax will decrease quantity demanded and, consequently, quantity supplied as well. So the deadweight loss represents the loss of what producers could have produced and earned, haven't the tax been placed?

    Am I right?
    Thank!
    (4 votes)
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    • ohnoes default style avatar for user Tejas
      The "perceived supply curve by consumers" is just what the supply curve appears to be to consumers. In this case it is just the supply curve plus the tax. A consumer will have to pay the producer and the tax. The perceived supply curve is both of those costs instead of just the producer cost.

      In the case of a perfectly elastic demand, the tax does not affect the final price that the consumer pays. Instead the price will be lowered such that the final price (the price plus the tax) remains the same. The lowering of the price will cause a decrease in quantity supplied. Note here that this is only true for perfectly elastic demand. In most cases, the tax is paid partially by the consumer and the rest by the producer, not all by the producer.

      This case most certainly leads to deadweight loss. The producers are not making as many units as is allocatively efficient.
      (5 votes)
  • male robot donald style avatar for user harry park
    So what does it mean if there is no consumer surplus?
    Does that mean consumers don't have satisfaction?
    They're not happy?
    (2 votes)
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  • leafers tree style avatar for user Boyu Zhang
    When tax imposed on the flag, why the difference between the new price and the original price is not the amount of the tax?
    (1 vote)
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    • ohnoes default style avatar for user Tejas
      Taxes are not always entirely passed onto consumers. Sometimes, the producer eats the tax. In this case, clearly the new price can't be more than the original price, because then no flags would be bought.
      (3 votes)
  • blobby green style avatar for user Matthew.M.Robinson
    What would happen if the tax was on buyers?
    (2 votes)
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  • leafers ultimate style avatar for user Thomas Wood
    Can America tax flags made in China?
    (1 vote)
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    • ohnoes default style avatar for user Tejas
      The United States places many taxes throughout the economy. For instance, America taxes all imports from China (called tariffs). The United States also has sales tax, which is a tax on the flag changing hands from the retailer to the consumer. There are other taxes in between.
      (3 votes)
  • purple pi purple style avatar for user Joshua
    In a PERFECTLY elastic demand curve, I suppose there would be no Consumer Surplus.
    However, there is a change in price and Sal does say that this is 'ALMOST Perfectly Elastic' demand. Therefore, should there not be a very small Consumer Benefit? If there was no Consumer Surplus, why would they both buying a flag from somewhere else? Is Price not a benefit?
    (1 vote)
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  • leafers sapling style avatar for user clarah
    How do you get the deadweight loss in this case? I"m a bit confused.
    (1 vote)
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    • starky ultimate style avatar for user Evan Li
      deadweight loss is equal to the difference between the surplus in a natural economy and the surplus in the new scenario. For this case, think about it like any other case, except that there is no consumer surplus.
      (1 vote)
  • male robot hal style avatar for user Dan White
    This is some what random but what things are have perfectly elastic demand or is it just a theoretical state? The only thing that came to mind as a obvious possibility is the minting of money.
    (1 vote)
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  • male robot donald style avatar for user harry park
    What does it mean when Sal says
    "The marginal benefit at any point for the consumer for that next unit is equal to the price they're paying"?
    (1 vote)
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    • piceratops ultimate style avatar for user saywachavez
      Since the demand curve is nearly horizontal (due to the quasi perfectly elastic demand) the marginal benefit of the consumer will almost be negligible . And when the curve is completely horizontal the marginal benefit is, indeed, the price the consumer is paying for the product, the consumer surplus is equal to zero.
      (1 vote)

Video transcript

Let's think about how a tax on a product might affect it, if the demand for it is very, very, very elastic. So what I've done here -- We're going to think about flags -- the market for a certain type of flag that's made in China. And to think about this flag -- think about it this way. If the price -- the price right now -- the equilibrium price between where the supply and the demand intersect -- the supply curve and the demand curve intersect -- is right about seventy dollars per flag. So this is a pretty nice flag. It's right at seventy dollars per flag. And the quantity demanded, in thousands per year, it looks like it's about twenty five thousand flags are demanded per year. Now if at the price were to go slightly above that equilibrium price,what's going to happen? Well, if the price goes slightly above that equilibrium price, people are going to say, "Well, I can go by the American flags made in Taiwan, or even the ones made in America, or made in Mexico, or made some place else. [Because...] "People won't be able to tell the difference from a distance." So I'm going to buy one of the substitutes -- [because] especially the ones from Taiwan or Mexico or wherever else. are identical to the ones made in China. So if the price for slightly -- even slightly higher, the quantity demanded would be much, much, much lower. And if the price were even a little bit lower, then people say, "I'm not going to buy the Mexican flag-- or the Taiwanese [or] American flags. I'm going to buy the ones that were made in China." And then the quantity demanded would be much larger. And so what you have here is a very large, a high elasticity of demand. So this right over here, this is almost perfectly elastic. If it was perfectly elastic, it would be completely horizontal. So this is almost almost almost perfectly -- perfectly elastic -- elastic demand. A very small change in price leads to a huge change in quantity. In particular a very small percentage change in price leads to a huge percent change in quantity. So let's say that -- that some government official decides, "You know what? [I] don't like the idea of American flags being made in China." So they decide to tax American flags made in China. So what they do is that they place a tax, they place a tax -- And once again I'll do a fixed dollar tax. It could be a percentage and if a percentage then it'll change the sup -- the supply plus tax curve It'll be -- the shift will will be a percentage change instead of a fixed change. But the fixed change is a little bit easier to draw, so I'll do that. So let's say that there is a tax -- Let me do that in a different color Let's say that there's a tax placed of ten dollars -- ten dollars per flag. Ten dollars, actually -- Let's do an even a smaller amount. Let's say that there is a tax placed of of one dollar per flag -- one dollar per flag. I'll make it a little bit larger. Let's say it's five dollars per flag -- five dollars per flag. So now what is the supply plus tax curve? So the supplier / just to make the flags in China and ship them to United States and get the story here even to get that first flag done even if is that in the most efficient way possible looks do you need at least looks like around fifty to fifty three dollars now Now they're going now they're still going to need that plus there's going to be a five dollar tax on it So supply plus tax is going to be that plus five dollars is going to be right around there Over here, you add five dollars. So at any given point, we're gonna add fivedollars to essentially what the consumer would have to see. \\So you would have a curve that looks something like this you would have a curve that looks something like this you would have a curve that looks something like this. That dotted line right over there is our supply is our supply plus tax. This right over here was just our supply --was just our supply. So you're essentially -- So let's think about what happens here. Your equilibrium price was at seventy before. Now our equilibrium price is still -- Our equilibrium price is still pretty much at seventy. But our equilibrium quantity has gone down dramatically. Our equilibrium quantity has gone down to -- our equilibrium quantity has gone down to -- I don't know. It looks like about eighteen thousand. Eighteen thousand flags per year. So who bore -- who bore the bulk of this right over here? So let's think about the tax revenue So the tax revenue in this situation is going to be eighteen thousand times the five dollars. So this is the five dollars right over here. That is five dollars -- and then times eighteen thousand -- times eighteen thousand. So this right over here is the tax revenue. That right over there is a tax revenue. Actually, let me draw a little bit more carefully so the tax revenue is This is going to be between this line right over here and five dollars. So just like that. So that's all the tax revenue. And notice. It all came out of the producer surplus. The original producer surplus -- the original producer surplus was -- Especially if we assume perfect elasticity -- The original producer surplus was this green rectangle plus this and plus this. Now this is going to be -- This little area right over here is going to be dead weight loss -- dead-weight loss. And all of that came from the producer's surplus. And then the all the tax revenue, also -- If you especially if you assume this top-line was horizontal -- also came out of the producer surplus. So in this situation where you had almost where you We could say, if if you do have perfect elasticity if you have perfect elasticity of demand for the product, The person who's going to bear the the brunt of the tax -- so -- is going to be the producer. The producer surplus is going to be eaten into from the tax. Bears -- bears the Actually that's not -- that's not (I'm not talking about the animal, "bears.") The producer, -- You know -- I'm not -- well -- The producer gets the burden the producer The producer gets the burden in that situation. And this is an interesting thing to think about. Because when you have almost perfectly elastic demand -- so a -- almost -- or if you said perfectly elastic demand -- a flat -- a flat demand curve right over here -- there's -- there's actually no consumer surplus, because the marginal benefit, even the incremental marginal or -- (I'm -- I'm being redundant with the words incremental and marginal.) But the marginal benefit at any point for the consumer for -- that -- for that next unit is equal to the price they're paying, when you have -- There's no -- There's -- Especially if the the especially if the demand curve is perfectly elastic -- and it's perfectly horizontal -- There is no area between the demand curve and the price paid. So there's actually -- There's isn't any -- even any consumer surplus to take any -- to take any of the -- to take -- to eat into. It all gets eaten out of the out of the producer surplus.