It’s time to pull our knowledge of economic surplus together
and realise the point of our previous articles. We've seen how taxes reduce surpluses and how the loss is shared between consumers and producers. But
how this loss is shared depends largely on the type of product being taxed. Some
goods are extremely important to us, and even if prices rise we tend to keep
purchasing them. What would this demand curve look like?
Figure A shows the
relationship between the price consumers must pay for an important good (lets
just call the good e for now ;- ) and the quantity of it they buy. The main
take away is that even if ‘e’ almost doubles in price from $5.00 to $9.00,
consumers still purchase one ‘e’. The mathematically inclined will notice that
an 80% increase in price only results in a 67% fall in the quantity purchased,
but the intuitive qualitative understanding of what is going on is more
important. Lets compare this to a less important good.
What about when we go out shopping for 'Alpaca Woven Foot
Loofahs'? Do we act the same way? I'm gonna go out on a limb and say that an Alpaca Woven Foot Loofah is a luxury, and as the price goes up we quickly stop
purchasing them in favour of cheaper alternatives. If the touch of treated alpaca fur on your skin is a daily staple you couldn't do without no matter what the price, well humour
me and read on. Figure B shows a demand curve where the relatively meagre $1.00
increase results in a drop in the amount of Alpaca Woven Foot Loofahs being
bought by 18. A 20% increase in price results in a 90% fall in loofah
purchases.
Now what’s the first kind of good we think of when we think
carbon tax: electricity! Which is a pretty
good example of a product we can't go without. It is said to have low price
elasticity of demand, because for a given change in price, demand will change
very little, like in Figure A. So what happens when a tax is put in place?
Before we see that, lets first have a look at high elasticity markets and tax. Figure C shows your average Alpaca Woven Foot Loofah market, where ten loofahs are bought
for $5.00. Note the elastic (ie flat) demand curve. Remember from How Labor’s new budget is going to reduce our surplus that the area above the price and
below the demand curve is consumer surplus, shaded in red here. Because the
supply curve represents how much it is costing producers to put together the
next loofah, producer surplus is the area above the supply curve and below the
price they are receiving, shaded in yellow.
Just as we did with cars, we are now going to throw
in a tax. Enter Figure D. For every Loofah that trades the government will take
sixty cents, and after buyers and sellers haggle with one another in the
marketplace, they finally decide upon a price and quantity that suits both
parties (producers and sellers that is). Unfortunately for the tender feet of
several participants, the economy enjoys three less loofahs. However if you
look closely, you’ll notice that consumers took a relatively small hit (that hit being represented by the purple slice).
Now sure consumers enjoy less loofahs,
and those that still purchase loofahs must pay a higher price, but comparing consumers' surplus before the tax to consumers’ surplus after the tax (red shade) there isn't a great deal of difference. Producers’ surplus on the other hand (yellow
shade) took a beating. Selling less loofahs at a much lower price has resulted
in a relatively large chunk of producer surplus disappearing (the dirty brown colour
underneath the purple). Of course the ever present winners take the tax,
represented by the blue colour, which while equalling a loss to the private
sector, is spent efficiently and equitably by government on public goods, so is
not supposedly a loss to society.
Figure E is where it starts to get relevant. Our electricity demand curve slopes downward steeply, representing our inability to switch to substitute products when price rises. As before the red is consumer surplus and the yellow is producer surplus.
Throw down a $6.00 tax per good and you've got Figure F. This time you can see that the loss of consumer surplus (purple area) is much greater than the loss of producer surplus When producers sell a product that people can’t do without, the burden of the tax is borne predominantly by consumers.
This is the complicated economic way of saying that if we
really need a good, companies can raise the price of it without fear of
people substituting the good for something else (or just going without). When
companies costs rise due to the tax, the tax will be passed onto consumers. I began
the previous article noting that politicians have been running their mouths
about not letting companies raise prices too high (whatever that exactly means,
but that’s an article for another day) due to the carbon tax. The reason I have
taken you through the painful process of mapping it out graphically is to
really show that companies raising prices and stickin' it to the consumer IS THE
ECONOMICALLY EFFICIENT OUTCOME, AS PREDICTED BY MAINSTREAM THEORY TO BE THE
NATURAL AND REQUIRED ORDER. There is no politically engineered spin that can
turn this into roses. Just as nature intended
electrons to gravitate towards one end of a water molecule, the tax is supposed
to raise prices and it is supposed to be borne by consumers (us economists love
to pretend we’re physicists). This string of articles makes no points for or
against a carbon tax, but I hope it cuts through the spin, and shows what
all those who are enlightened (including political economic advisers) already
know.
Producer surplus
Consumer surplus
Carbon tax
Price increases
