The Determinants Of The Deadweight Loss

What determines whether the deadweight loss from a tax is large or small? The answer is the price elasticities of supply and demand, which measure how much the quantity supplied and quantity demanded respond to changes in the price.

Let's consider first how the elasticity of supply affects the size of the deadweight loss. In the lop two panels of Figure 5, the demand curve and Ihe si2e of the lax are the same. The only difference in these figures is the elasticity of the supply curve. In panel (a), the supply curve is relatively inelastic: Quantity supplied responds only slightly to changes in the price. In panel (b), the supply curve is relatively elastic: Quantity supplied responds substantially to changes in the price. Notice that the deadweight loss, the area of the triangle between the supply and demand curves, is larger when the supply curve is more elastic.

Similarly, the bottom two panels of Figure 5 show how the elasticity of demand affects the size of the deadweight loss. Here the supply curve and the size of the

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