Mankiw's Principles of Microeconomics Chapter 8

1. How important do you think the concept of a deadweight loss to taxation is?  Why or why not?

Our founding father Benjamin Franklin once said “but in the world nothing can be said to be certain except death and taxes.”  Most of us view taxes as a necessary evil to achieve an organized society. However, have we ever drilled down further and considered the actual cost of the tax? When a product or service is taxed both the buyer and seller share in that cost. The true equilibrium price isn’t what’s paid or received, instead the equilibrium shifts and buyers pay more while sellers receive less. The question of what’s lost in the process is considered deadweight loss. Deadweight loss should be considered an important concept because in the end, people respond to incentives and the taxation of products and services negatively impacts the free market, therefore changing the behaviors of the consumer or supplier.

2. Should politicians and other taxing authorities consider deadweight loss when making their decisions?

When taxation policies are developed, one of the factors the government considers is the type of product being taxed. They ask the question, is this product elastic or inelastic in the demand & supply? Consider for a moment that the government started to tax all smart phones. I don’t know about you, but I consider my smart phone a rather inelastic product from my personal demand perspective. As you can see below in figure 1, on a macro level, while prices may changes substantially due to the imposed tax, products with inelastic demand maintain their quantity sold at a significantly better rate than products with elastic demand which results in a lower amount of deadweight loss. The goal of any taxation policy is to minimize the impact to the free market; consequently our government should consider deadweight loss when drafting tax policy.