ECO 100 - Lecture 8 - Fall 2026
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Overview
Matthew Baker reviews price ceilings and floors, then develops tax incidence using supply-and-demand diagrams to show how a per-unit tax creates a wedge between the price consumers pay and the price suppliers receive. A $3 gasoline tax reduces quantity from 4 million to 3 million gallons, generates $9 million in tax revenue, and creates $1.5 million in deadweight loss; the lecture connects these results to elasticity and the welfare theorems.
Key takeaways
- A per-unit tax creates a vertical wedge between the price buyers pay and the price sellers receive; in the gasoline example, a $3 tax separates a $6 consumer price from a $3 supplier price.
- Tax incidence depends on relative elasticity rather than on which party legally remits the tax: the less responsive side of the market bears more of the burden.
- In the gasoline example, a $3 tax lowers quantity from 4 million to 3 million gallons, raises $9 million in revenue, and creates $1.5 million in deadweight loss.
- A binding minimum wage of $15 in the labor-market example leaves 1,500 jobs available even though 3,000 units of labor are offered, so a rationing process determines who works.
- A perfectly inelastic insulin demand curve means a production tax can be passed fully to consumers without reducing quantity or creating the usual deadweight-loss triangle, though it burdens buyers of an essential good.
- The welfare-theorem policy prescription is to pursue distributional goals through transfers, such as housing assistance or income support, rather than changing market prices with controls.
Chapters
- Matthew Baker provides a practice exam in class and as a PDF, designed to resemble the real exam's length and format.
- Top Hat contains 60 optional practice questions; submitted answers cannot be changed, and selected questions will be reviewed in class.
- The exam is scheduled for the following week, allows a pen or pencil and four-function calculator, and prohibits phones and leaving during the exam.
- Baker compares interventions with the market equilibrium that would exist without a ceiling or floor.
- Consumer surplus is below demand and above price, while producer surplus is above supply and below price.
- A binding rent ceiling reduces supplied housing from 600 to 400 units while quantity demanded rises to 800, creating a shortage and deadweight loss.
- The illustrated welfare result assumes the 400 units go to the highest-value renters; queues, kickbacks, and other rationing methods can waste resources or change who receives housing.
- A minimum wage is a price floor: workers supply labor and businesses demand it.
- In the example, the market wage rises from $10 to a $15 minimum wage, and firms demand only 1,500 units of labor while workers supply 3,000.
- The 1,500 available jobs must be rationed, and the workers who get them are not necessarily those with the lowest reservation wages.
- A binding floor reduces total gains from labor exchange and creates deadweight loss; salary caps, including NBA maximum salaries, are examples of price ceilings.
- A sales tax creates a wedge between the amount buyers pay and the amount suppliers keep, regardless of which side formally remits it.
- A receipt example distinguishes the consumer's total payment from the supplier's net revenue, with tax revenue going to government.
- In the wine example, a $1 tax turns a $10 pre-tax price into a $10.60 consumer price and a $9.60 supplier price.
- That example assigns 60 cents of the tax burden to the consumer and 40 cents to the supplier, illustrating incidence as changes relative to the no-tax price.
- The gasoline market begins at $4 per gallon and 4 million gallons per day before tax.
- When consumers are assigned a $3-per-gallon tax, their effective willingness to pay falls by $3 at every quantity, shifting demand downward.
- The new equilibrium has suppliers receiving $3 per gallon and consumers paying $6, with the $3 difference equal to the tax.
- The resulting quantity falls below the original 4 million gallons because buyers and sellers adjust to the tax.
- Assigning the $3 gasoline tax to producers shifts supply upward by $3 because each sale now adds a tax cost.
- The supply-shift method yields the same outcome as the demand-shift method: consumers pay $6, suppliers keep $3, and quantity is 3 million gallons.
- A soda example represents a $1 tax as a vertical wedge between the two prices; a buyer price of $1.75 leaves the cafeteria with $0.75 after tax.
- Tax incidence depends on market adjustments, not on whether the receipt or the supplier formally lists the tax.
- Before tax, producer surplus is a triangle with base 4 and height 4, giving 8; consumer surplus has base 4 and height 8, giving 16.
- Pre-tax total surplus is 24, representing $24 million when the graph's units are interpreted in millions of dollars.
- After the tax, producer surplus is 4.5 and consumer surplus is 9, using the new quantity of 3 million gallons.
- Tax revenue is a rectangle with a $3 tax per gallon and 3 million gallons sold, totaling $9 million.
- Post-tax surplus including revenue is 4.5 + 9 + 9 = 22.5, compared with pre-tax total surplus of 24.
- The $3 gasoline tax therefore creates $1.5 million in deadweight loss in the example.
- The deadweight-loss triangle has base 3 million gallons and height $1 per gallon, so its area is 3 × 1 ÷ 2 = 1.5.
- The lost surplus represents trades that would have generated value because buyers valued the gallons more than suppliers' costs, but that no longer occur.
- With relatively flat, elastic demand, a tax causes the supplier price to fall substantially while the consumer price changes less, so suppliers bear more of the burden.
- With steep, inelastic demand, consumers' price rises more, allowing suppliers to pass more of the tax on to buyers.
- A claim that gasoline producers pass a tax on to consumers is an economic claim about demand responsiveness, not a rule that applies regardless of elasticity.
- A relatively flat supply curve can also shift more of the tax burden to consumers because suppliers adjust quantity strongly.
- A fixed-size tax wedge creates a larger deadweight-loss triangle when both supply and demand are relatively flat and quantities respond strongly.
- Steep, inelastic supply and demand produce a smaller quantity change and a smaller deadweight loss.
- With perfectly inelastic, vertical demand for insulin, a $0.20 production tax is passed fully to consumers without changing the quantity traded.
- The insulin example has no deadweight loss from reduced quantity, but taxing essential goods raises concerns because people cannot readily avoid buying them.
- The first welfare theorem says competitive markets produce socially efficient outcomes; ceilings, floors, and taxes can reduce gains from exchange.
- The second welfare theorem suggests pursuing goals such as housing affordability by changing people's resources rather than distorting market prices.
- Instead of rent control, the lecture recommends letting housing prices adjust and giving people money; instead of a minimum wage, one alternative is a $1,000 monthly universal basic income.
- Taxes on particular products can obscure scarcity signals in prices, while income or property taxes may raise revenue with less distortion to those product markets.
- Baker previews market power, pollution externalities, and information and quality problems as reasons markets may fail.
- Healthcare is cited as a market where fixed prices, regulations, and uneven taxes can make observed prices hard to interpret.
- The course will examine cases where intervention may be warranted, then consider addressing market failures by creating or improving markets.
Transcript excerpt
0:01 Okay, now after a lot of shuffling stuff around, we still have like bar chairs here. I wonder what kind of event they have uh planned for later. Um yeah, you never know quite what's going to happen when you when you show up here class. Uh anyways, here we are. Lecture 8, our last I guess uh lecture where we'll talk about any uh introduce any new material before the big uh exam a week from today, right? Um okay. And so we'll talk a little bit about taxes and tax incidents and maybe I'll circle back and say a little bit more about market intervention in general. Um but let me first take care of the administrative stuff. Uh today is uh lecture 8 and I promised you some review materials. So I do have I put in various parts of
0:49 quadrants of the classroom. We have here a practice exam. There's some copies back there. There's some on a bar chair in the back uh over there and there's some on this table here. You don't need to grab them now. Um but you can grab them as you go. Also, I put a copy of this uh the PDF on top hat. Uh so if you want to download it there, you can. Uh and again, it'll mirror the actual length and form and all that stuff of the exam pretty closely. Is there a question? Yes. Um on the first exam material IC says first exam in progress enter that's the actual online exam. >> Oh okay. So you you uh you stole my thunder there a little bit. So I also put a um I also put some practice questions on top hat. Uh there's I think
1:38 60 questions. Is that what you're looking at?
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Summary, takeaways, and chapters were generated by AI from the video's transcript and may contain errors. The video belongs to its creator, Matthew Baker.