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Taxes in the competitive market model

MarketLink allows taxes to be imposed on either sellers or buyers. Tax experiments illustrate the effect of elasticities on the split of tax burden between sellers and buyers. This section describes two experiment configurations for classroom demonstration of the effect of taxes. The first configuration is for a sales tax. That experiment only involves a tax imposed on buyers after six periods of trade in a stationary market. The second experiment is slighly more complicated. In the second experiment, an excise tax is initially included for sellers. After four periods the excise tax is removed. At that point there is no tax. After four more periods, a sales tax is imposed on the buyers. The advantage of the second experiment is that it demonstrates that the split of the tax burden is unaffected by the side of the market that the tax is imposed on.

Experiment configuration for a sales tax

The configuration included below is for a double auction experiment with a demand function that is twice as steep as the supply function, so that demand is less elastic than supply. During the first five periods of the experiment, the demand and supply remain fixed. Beginning in period six, there is a sales taximposed on the buyers, which is equivalent to a downward shift to buyers values (or an inward shift to the demand function). This experiment can be conducted with up to 56 students (28 sellers and 28 buyers). Buyers and sellers are added in pairs, so that the equilibrium price remains fixed so long as there are an even number of students connected to the experiment.

The experiment can be used to demonstrate that when a sales tax is added when the demand is twice as steep as the supply, the price shifts up by 2/3 of the amount of the tax and the buyers therefore pay 2/3 of the tax, while the sellers pay 1/3. The issues of sales and excise taxes are described in Section 3.4.1 of the lecture notes.

To add the configuration to your profile for the double auction competitive market with a szles tax, click on the button below.

Experiment configuration for comparison of an excise tax to a sales tax

The experiment configuration below is slightly more ambitious than the sales tax configuration. The experiment has an excise tax for periods 1 - 4, then no tax for periods 5 - 8, then a sales tax for periods 9 - 12. The experiment is slightly longer than the sales tax experiment: it has twelve periods, each of which is three minutes long, and it also has 20 seconds between periods, so that the total experiment length is approximately 40 minutes. For students who have already been through a double auction experiment, instructions can be kept short so that the experiment can be completed in under one hour.

This experiment is useful because it illustrates the idea that the split of a tax burden is independent of the side of the market that the tax is nominally imposed on. The surplus earnings from the first four periods with an excise tax can be compared to the surplus earnings in the middle four periods without the tax. The surplus earnings from the last four periods can also be compared to the middle four periods and to the first four periods to see the effect of the two taxation schemes.

Since there is some time required to adjust to the competitive equilibrium in each of the three parts of the experiment, it is typically most effective to compare the final periods from each part (in this case, periods 4, 8, and 12).

Material for students on the topics of excise taxes and the comparison of excise taxes to sales taxes are covered in Sections 3.4.2 and 3.4.3 of the lecture notes.

To add the configuration to your profile for the double auction competitive market with a szles tax, click on the button below.

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