III. The microeconomic role of government
A. Basic policymaking tools
2. Taxes and subsidies
a. Taxes

    (3) Who really pays the tax?

    See The Economic Effects of Taxes worksheet -- review left panel

    In general, market forces make both buyers and sellers share the burden of the tax.
    Buyers pay a higher price because of the tax (Pbt > P*)
    Sellers receive a lower price because of the tax (Pst < P*)
    How a tax is divided between buyers and sellers is called tax incidence

Lessons noted in worksheet:

    Note 1: It is not government laws but the laws of supply and demand which determine who ultimately pays a tax.

    Note 2: Buyers tend to pay more of a tax when demand is inelastic compared to supply, and sellers tend to pay more of a tax when demand is elastic compared to supply.
    (the side of the market with fewer substitute options gets stuck with more of the tax.)
     Tax--> a hidden struggle
    Sellers want buyers to pay it
    Buyers want sellers to pay it.
    Division of the burden depends on who has the more elastic response.

    Despite this you find lawmakers arguing all the time about who should be paying some particular tax.
    Social security: 50/50: only by statute. In practice, since S of labor is almost vertical, workers pay taxes on their incomes.
    Any increase in employer costs gets passed on.
    Employers don't care whether they give you a $ of income or a $ of benefits. Workers pay it in the end.
    Same with health insurance, parental leave, etc.

    Note 3: Since it is only the size of a tax which matters and not who is formally assessed it, you can show any tax any way you please:
    you can simply insert a "wedge" equal to the size of the tax between supply and demand, or shift supply up or shift demand down by the amount of the tax.
    By convention, most economists shift supply up, but feel free to do whatever makes most sense to you.
   How I think of it: tax = a "fake cost"
    Simply transfers some revenue from the market to the government

    b. Subsidies    -- Why? To encourage production/use

    (1) Price and output effects

Subsidy = a "negative tax":  Ex: rental subsidy     STEP 1: Shift the supply curve DOWN by the amount of the subsidy.     Draw S' as a dotted line to reinforce the fact that the original supply curve captures the true marginal cost (MC) S' = MC - sub

    STEP 2: Find Qsub, the equilibrium quantity with the subsidy.
    At P* - sub, there is an excess demand at Q*, so output rises to where D and S' intersect

    STEP 3: Find PBsub (the new price buyers pay) = the height of D at Qsub.
    the demand curve at the new quantity. Note that PB does not include the subsidy--that comes from the government

    STEP 4: Find PSt (the new price sellers end up with) PSt = PBt + sub
    Note: PSsub = MC at Qsub
    PSsub INCLUDES the subsidy because that amount comes from the government.

    (2) Efficiency and equity effects

    There are now 3 parties to consider: consumers and producers--as before; and the government

See subsidy worksheet     Sub spending      = sub x Qsub = (PSsub - PBsub) x Qsub

    The gains in PS and CS are not "stolen" from each other; they are paid for by taxpayers. (Can think of buyers and sellers facing prices in separate markets)

    Unless we specifically desire to increase output and/or use, subsidies also create inefficiency