How do tax incidence and DWL arise from a wedge between two prices?
A tax creates Pc−Ps=t, reduces trade, and burdens the less elastic side more.
Follow the cause and effect
Solve demand=supply for P0,Q0.
Use Qd(Pc)=Qs(Ps) and Pc−Ps=t.
Compare Pc and Ps with P0, then compute tQt and half the wedge times lost trade.
The model you are using
Conditions for this model
Competition, no externalities, linear curves and no collection or avoidance costs.
The exam trap
The statutory remitter need not bear the full economic burden.
Connect the reasoning to the graph
What changes
- The vertical wedge at Qt separates buyer and seller prices; the triangle from Qt to Q0 is DWL.
What stays fixed
Competition, no externalities, linear curves and no collection or avoidance costs.
Keep these conditions throughout the comparison; change only what the case above specifies.
What to inspect
Compare Pc and Ps with P0, then compute tQt and half the wedge times lost trade.
Compare before and after, and locate the conclusion on the graph.
5 MINUTES · TRANSFER THE IDEA
Can you explain it without the lesson?
Draw a tax with much steeper supply and predict incidence before calculating.