Saturday, July 13, 2019

Taxation: Do Costs determine Prices?

In the advent of intense competition, due to rise of  innovation and technology, domestic consumers are benefiting from higher standard of living, at lower costs. Due to this exponential expansion of growth, contemporary economists are analyzing in great detail utilizing a menagerie of statistical models to provide civic leaders the most precise information—these leaders feel compelled to make an informed decision while making public policy.

While these publicly elected officials engage in that decision making process, the subject of taxes always seems to rear its ugly head. For some, they see taxes as a necessary function to fund the operations of government. While others may quibble regarding the role of Government in today's society; the notion of excess taxation always strikes as a rapier into the hearts and minds of the general public, nonetheless, it still something of worthwhile analysis.

While the political experts engage in verbal combat over the notion of taxation, two questions always rise during these debates is about this notion: Who pays the tax? Is the tax passed down to the consumer?

Before these questions are analyzed, let us recall the supply and demand model. With this supply and demand model, there comprises two intersecting curves. The first curve, rising from left to right, is the supply curve. This represents the supply of a certain "good" provided to the market. The demand curve, sloping downward left to right, represents the consumers desire for that particular good. Both curves are analyzed graphically as follows: The horizontal axis(x-Axis) shows the quantity of the good, and the vertical axis(y-axis) shows the price of the good. As the two curves intersect, they reveal the Equilibrium point. This is the market price for that good, assuming all things are  constant(ceteris paribus).

Back to our two questions: Who Pays the Tax? Is the tax passed down to the consumer? Before we answer these questions, more analysis must be completed, so patience is required. With regards to taxation, it must be conceded that the notion of taxation is a trade off. A trade off: In a republic, in order to have various Government "positive liberties", namely, public goods, to be provided to its citizens, taxation is required to underwrite this political model. Since it is a trade off, that means there is an economic cost related to having Government provide these "positive liberties". We shall keep our analysis of the costs restricted to taxation, as the costs are many. Oh, and speaking of cost, in an economic sense, taxation is a cost.

Economic costs play a role in the bringing of goods to the marketplace. Each firm must gather up all the factors of production in order to bring their goods to consumers to purchase. Those individual firms must pay some sort of tax on those goods. Now is the time we must address the first question: Is the tax passed down to the consumer?

Here is the answer: Yes and no...it all depends. Yes: If the good's costs are increased due to taxation, and the consumer sees the good as inelastic, meaning they are less concerned with the price of the good relative speaking, the consumer will simply buy that product. When this happens, the consumer simply absorbs "some" of the costs of the good. No: If the price of the good pushes the price elasticity to the point, for the consumer, where the good goes from "inelastic" to "elastic", the firm selling the good begins to lose gross revenue. This is due to the fact that consumers have found alternative uses for that product, due the price increase. Based upon these answers, it all depends...depends on the price elasticity of the consumer purchasing the good. In both cases, the consumer pays the cost; this is due to the fact that owners of firms are also consumers. So, firms and consumers pay the tax.

In the latter case, once revenues decline, firms are unable to purchase more of the inputs for that good, subsequently increasing the scarcity factor, which leads to a higher economic cost of that good. This cost is absorbed by firm, due to the fact it has declining revenues and increasing input costs for the good; the consumer also is impact, as the good’s economic cost increases due to scarcity.

Now it is time for the supply and demand model to be revisited. As previously stated: The equilibrium point is the market price. Stated differently, this is the optimal price firms can sell the good. If they sell the good at a higher price, based upon elasticity of the good, they will sell fewer  units. This is an instance where the economic cost of the good is paid for by the firm.

Since the equilibrium price is the optimal price, as previously stated, the cost is passed to the consumer; the final price is not determined by cost. If the good’s price was determined by the cost, the firm could simply raise the price to meet the costs of the good, but the business runs the risk of having declined sales. The equilibrium price demonstrates the power the consumer has with the sale of the good.

The discussion of taxes is never a pleasant one. It always lends itself to cantankerous banter, and distribution of mis information...bordering on prevarication. When individuals state that the cost of taxation, of a good, can be simply passed onto the consumer, this is a misspeak of the facts.

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