Tax Incidence & DWL

I think we both can agree the perfect late night snack for a long study session is 2:00 AM Insomnia Cookies fresh from Uptown.

As it stands, let's imagine that the current market for Insomnia Cookies looks like this:

This means that our equilibrium price per cookie is $3 and the equilibrium quantity is 100 cookies.

It's also important to note that as is, our consumer and producer surplus lie here:

Now imagine that the Oxford City Government decides they want to implement an excise tax on the current cookie market.

An excise tax is a tax on a particular good or service.

Let's imagine that the tax they impose is $2 per unit on producers. When there's a per unit tax on producers, the supply curve will shift up by $2 to represent the new increase in price due to the tax.

Here's the catch though...

The excise tax does not increase the price of the good by the exact same amount. Dependent on elasticity of demand and supply, the tax burden will be split between consumers and producers!

The impact of the excise tax

Let's start by understanding the impact of the excise tax on consumers.

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