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M05.L06 — Elasticity Applications: Taxes, Housing, and Australian Markets

Module: Module 05 — Economic Surplus and Elasticity Lesson: L06 of 06 Duration: ~30 minutes Level: Introductory Provenance: OpenStax Principles of Microeconomics 3e | Khan Academy Microeconomics

Learning Objective

Analyse tax incidence and deadweight loss using elasticity in Australian markets.

Tax Incidence and Elasticity

Tax burden falls more heavily on the inelastic side of the market (buyers or sellers). Deadweight loss (DWL) occurs when taxes reduce TS below its maximum.

Australian examples: - Tobacco tax: Inelastic demand → consumers bear most burden. - Fuel excise: Inelastic demand → minimal quantity change, high revenue. - Housing: Inelastic supply in Sydney → taxes raise prices more than quantity.

Worked Example

Tax Incidence in the Sydney Housing Market

  1. Pre-tax: Equilibrium price = $1M, quantity = 1,000 homes.
  2. Tax: $50k levy on sellers (supply shifts left).
  3. Post-tax: Buyers pay $1.04M, sellers receive $0.99M, quantity = 950 homes.
  4. Burden: Buyers pay 80% of tax (\(40k), sellers 20% (\)10k) due to inelastic supply.
  5. DWL: Triangle area = \( \frac{1}{2} \times 50 \times (1.04M - 0.99M) \) = $1.25M.

Common Misconception

"Taxes always hurt sellers more than buyers."

Tax burden depends on relative elasticities, not who physically pays the tax.

Key Takeaways

  • Tax incidence is split based on relative elasticities.
  • DWL is larger when elasticity is high.
  • Sydney housing taxes show high buyer burden due to inelastic supply.
  • Fuel and tobacco taxes exploit inelastic demand.

Practice

  1. If demand is perfectly elastic, who bears the tax burden?
  2. Draw a market with elastic demand and inelastic supply. Show tax burden.
  3. Why does Australia tax tobacco heavily despite DWL?

Further Resources

Provenance: OpenStax Principles of Microeconomics 3e | Khan Academy Microeconomics