Question

How do excise taxes, price floors, and price cielings affect supply demand curves, and how can I find deadweight loss from these?

Answer 1

Soln.

Excise taxes - They are levied as a source of revenue. The implication of excise taxes shifts down the demand curve, which leads to surplus of the good.

Price floors - Price floors constrains a price from falling below a certain level. The impact of price floor is experience when it is set above the equilibrium price as, quantity supplied will exceed quantity demanded, and excess surplus will result.

Price ceiling - The impact of price ceiling is experienced only when the ceiling is set below the free-market equilibrium price. The demand of goods will increase as more people will be willing to pay the lower price to get the good while producers will be willing to supply less, leading to a shortage.

Dead-weight loss - Steps to calculate dead-weight loss are mentioned below

1. Let the original price of the product being measured be P1.
2. Let the new price of the product after the price ceiling, price floor or tax is imposed be P2.
3. Let the original quantity demanded of the product being measured be Q1.
4. Let the new quantity demanded of the product after the price ceiling, price floor or tax is imposed be Q2.
5. Therefore, dead-weight loss is calculated as .5 * (P2 - P1) * (Q1 - Q2).