Introduction: How to Graph the Burden of Tax
This Instructable is designed to explain and illustrate how taxes affect consumers, producers, and the economy as a whole. You will follow step by step instructions to learn how to graph the economic burden of tax. You will then analyze the results of your work, and hopefully gain a general knowledge about microeconomic taxation.
Before you begin, understand that the economic graph of supply and demand is a model; it illustrates a concept based on select economic assumptions- it does not reflect a precise reality. In the microeconomic models below, we hold all else constant, to show the effect of a single input (taxation) on a specific economy (gasoline and candy bars).
Step 1: Obtain Your Supplies
-1-2 sheets of paper
-4 highlighters/colored pencils (each a different color)
-a ruler (OPTIONAL)
-a calculator (OPTIONAL)
*NOTE: you will also need a very basic understanding of algebra.
Step 2: Part 1 (Graphing & Calculating)
1.) Draw a simple graph with an x and y-axis.
2.) Title the graph Gasoline.
*NOTE: make sure the graph is big enough for proper analysis; a good size graph will be about half a page length.
1.) Label the x-axis Quantity and the y-axis Price.
2.) Identify that Price is measured per gallon and Quantity is measured in # of gallons.
*Use the image above as a reference for the slopes in part 3 and 4.
3.) Draw a line with a positive slope that is marginally steep
4.) Draw a line with a negative slope that is very steep.
*NOTE: remember that this is a conceptual model (the lines do not have to be exact so a specific slope is not given); it is also not necessary to have the lines touch the axes.
1.) Label the positive slope S (supply).
2.) Label the negative slope D (demand).
3.) Put a point where S & D intersect and label it E (equilibrium).
1.) Draw a vertical,dashed line from E to the x-axis.
2.) Label where this dashed line meets the axis 1,000 Q.
3.) Draw a horizontal, dashed line from E to the y-axis.
4.) Label where this dashed line meets the axis $3.00 P.
*NOTE: before taxation, the equilibrium quantity for gas is 1,000 gallons and the equilibrium price for gas is 3 dollars a gallon (consumers pay $3 a gallon for gas and producers receive $3 in sales revenue per gallon of gas).
1.) Draw a line parallel to S approximately an inch to the left of S.
2.) Label the new line S1.
3.) Using an arrow, show that S shifted to S1.
4.) Label the arrow tax.
*NOTE: the shift in supply was a direct result of taxation; see how this change will affect E,P, and Q.
1.) Draw a point where S1 intersects D.
2.) Draw a vertical, dashed line from the new point to the x-axis.
3.) Label where the dashed line meets the axis 900 Q1.
*NOTE: the equilibrium quantity has shifted from 1,000 gallons to 900 gallons of gas.
1.) Draw a new point where the vertical dashed line from Step 7 meets S.
2.) Draw a horizontal dashed line from this point to the y-axis.
3.) Label where the dashed line intersects the axis $2.90 P2
4.) Draw a horizontal, dashed line from the point intersecting S1 & D to the y-axis.
5.) Label where the dashed line intersects the axis $3.30 P1.
*NOTE: the imposed tax has shifted the equilibrium price up 30 cents to P1 (consumers now pay $3.30 per gallon of gas), and down 10 cents to P2 (producers now receive $2.90 in sales revenue per gallon of gas).
1.) Take a highlighter or colored pencil and color in the rectangular region showing the change from P to P1.
*NOTE: DO NOT color past the Q1 marker; use the image above as a reference.
2.) Calculate the economic Cost to Consumers in this economy by finding the area of the colored rectangle: A=(3.30-3)(900-0). Write your answer at the bottom of the page, and identify the specific color used to show Cost to Consumers.
1.) Take a highlighter or colored pencil and color in the rectangular region showing the change from P to P2.
*NOTE: DO NOT color past the Q1 marker; use the image above as a reference.
2.) Calculate the economic Cost to Producers in this economy by finding the area of the colored rectangle: A=(3-2.9)(900-0). Write your answer at the bottom of the page, and identify the specific color used to show Cost to Producers.
1.) Take a highlighter or colored pencil and color in the triangular region showing the change from Q to Q1.
*NOTE: DO NOT color past the Q1, S,and D markers; use the image above as a reference.
2.) Calculate the economic Dead Weight Loss in this economy by finding the area of the colored triangle: A=(1/2)(3.3-2.9)(1,000-900). Write your answer at the bottom of the page, and identify the specific color used to show Dead Weight Loss.
1.) Take a highlighter or colored pencil and make a border around the rectangular region encompassing Cost to Consumers and Cost to Producers.
2.) Calculate the Total Tax Revenue in this economy by finding the area of the rectangle border: A=(3.3-2.9)(900-0). Write your answer at the bottom of the page, and identify the specific color used to show Total Tax Revenue.
*NOTE: the first part of the Total Tax Revenue equation is (3.3-2.9); this is the imposed tax per gallon of gas.
Step 13: Part 2 (Analyzing)
Using your answers, determine whether consumers or producers had the greater burden of tax (the higher cost).
In our gasoline example, we saw how consumers paid 30 cents more per gallon and producers lost 10 cents per gallon in revenues due to taxation. This interference in an economy unintentionally produces dead wight loss in which money is not gained by any party- it is merely lost due to market inefficiency. From this exercise, we can conclude that the burden of an imposed tax on a specific good will be shared by both consumers and producers; however, this burden is rarely shared equally. As a consumer, it is important for you to know how taxation can influence your purchasing power and which goods will be more burdensome (more costly) to you.
*Use another piece of paper or use the back of your current sheet.
Look at the graph above depicting the economy for Candy Bars.
Using your new knowledge of the burden of tax, calculate how much the tax is per candy bar, the economic Cost to Consumers, Cost to Producers, Dead Weight Loss, and Total Tax Revenue.
From the Candy Bars example we can see how producers have the greater burden of tax in this economy. If a tax is placed on candy bars, producers will loose 40 cents of sales revenue per bar while consumers will pay 10 cents more per bar.
*NOTE: gasoline and candy bars had two very different results; as consumers we care more about a tax increase on gasoline than we do about candy bars because the burden of tax is significantly different for these two goods
So why did it change...
Step 17: Why It Changed & Why It Matters!
Remember Step 3 had you draw the slope of the supply and demand curves based on steepness. These slopes (steep or flat) are called price elasticities; the slope reflects how a good's supply and demand change compared to its price over time. Very inelastic goods (steep slopes) do not have a tendency to change when prices rise/fall. These goods are necessities and cannot be substituted easily: gasoline, water, toilet paper! If a tax is imposed on inelastic goods, consumers will have the greater burden. Elastic goods (flat slopes) are not necessities and typically have multiple substitutes so we tend to buy less when prices are high, and more when prices are low: candy bars, jewelry, TVs. If a tax is imposed on elastic goods, producers will have the greater burden.
Taxation affects us all. Not all taxes are bad; as you have seen, they provide significant revenue for the government. However, understanding the burden of tax is important, especially when it involves the goods we value greatly. Next time you hear about a tax initiative, use your new knowledge and think about how much the policy will cost you and the economy as a whole.