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Hurrah for Caroline Baum!

We have repeatedly discussed — both recently and in the past — that oil price increases are not like taxes.

Finally, someone else has come to the same realization. It’s a pleasure to see this argument from someone more eloquent and erudite than I:

It’s axiomatic that higher gas prices act like a tax on consumers.

It’s also dead wrong. There is nothing about a demand-driven rise in oil prices that will discourage oil production and reduce the quantity supplied to the market, which is precisely the effect of a tax.

Tax something more, and you get less of it: Now there’s an axiom you can hang your hat on. If the government imposes a tax on a good or service, the effect will be to shift the demand curve back (inward) or the supply curve upward, depending on whether the tax is levied on the consumer or producer. In both cases, the quantity supplied at the new equilibrium is lower than it was before.

Let’s walk through an example before looking at why the analogy of oil prices as a tax is off-base. If the government levies a tax on widgets that the buyer is responsible to pay, the same widget a consumer paid $5.00 for previously now costs him $5.50.

The imposition of a tax, which raises the effective cost to buyers, makes widgets less attractive, reducing the demand for them at any given price. The effect is expressed as a shift inward, to the left, in the demand curve, reducing the quantity of the widgets sold.

Thank you Caroline!

Sources:
Higher Oil Prices Are Not Like a Tax. Really
Caroline Baum
Bloomberg, May 24

http://quote.bloomberg.com/apps/news?pid=10000039&sid=agrHqq5dSJcg&refer=columnist_baum

Oil price rises are not tax increases

http://bigpicture.typepad.com/writing/2003/10/repeat_after_me.html

Oil Prices Are Not Taxes II

http://bigpicture.typepad.com/comments/2004/05/oil_prices_are_.html

Category: Finance

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