eco1000 economics semester one, 2004 lecture five
TRANSCRIPT
ECO1000EconomicsSemester One, 2004
Lecture Five
Cancellation of Workshops Due to small numbers, the workshops on
Monday 11-1 and Monday 12-2 have been cancelled effective immediately.
Students are requested to choose: Tuesday 10-12 (T124) if possible. If this is not appropriate, please see the course
leader.
Class test 1 Reminder (internals incl. Wide Bay students) April 7 (Next Week) Test open from 5 pm-8pm 25 questions Based on lectures & all
workshop activities Make sure you have
Graph paper (to help you work out the correct answers)
Rulers and pens Calculator Text Book etc
How to Access the Test (internals) The instructions are as follows… (students at the lecture were shown
the online procedures) Please note: students who have not
payed their guild fees or non-deferred HECS may not be able to access the test. An alternative can be arranged if this occurs.
In Case of Technical Difficulties… Note the problem Contact the CMA administrator If a solution is not forthcoming, contact
your lecturer the next morning There will be an electronic record of all those
who tried to, or actually accessed the test You must be on this list to qualify for further
consideration
Outline or Plan of Today’s Lecture Material Covered:
Module Two, Part Three
Reading: Text Chapter Six, Hakes and Parry Chapter Six
Topics: Markets and Government Policy
Purpose or Objectives of This Lecture
You will learn about: The effects of government policies
(ceilings and floors) on prices The effect of taxes on the price of a good
and quantity sold The burden of taxes on consumers or
producers
Relevant Economic Principles 6. Markets are usually a good way to
organise economic activity 7. Governments Can Sometimes
Improve Market Outcomes
A Starting PointFree Markets
Defining ‘free’ (unregulated) markets There is freedom of production &
consumption Most economic activity is done by the
private sector There should be competition amongst
buyers and sellers But private contracts have legal
backing
The Benefits of Free Markets Are: (according to classical theory) Individual freedom Efficiency in production
because competition leads to innovation
Allocative efficiency resources used in most efficient way the best way to shift goods & services
around Higher average standards of living
‘Creative Destruction’ Technological innovation increases
efficiency Productivity increases Labour is replaced by capital
(some) labour shifts to ‘new’ industries ‘New’ industries became a greater
proportion of the national economy
Reasons Why Governments Might Limit Market Freedom
To achieve equity or greater equality To protect the economically weak To protect or nurture a socially
desirable industry To gain votes To prevent or limit externalities Ensure social or economic stability
Government Intervention Aimed
at Producers
Assistance for Producers Tariffs on imported goods Mandated monopolies Preferred purchasing agreements Subsidies
Subsidising Producers Grant (lump sum payment)
eg for start-up capital Tariff (tax on imported/competing
product) Tax deductions on expenditure Subsidised infrastructure & research Payment per unit produced
The Effect of a Subsidy
Price
Quantity
S0
P0
Q0
D0
P1
Q1
S1
Points to Note A subsidy/unit effectively lowers the cost
of production The supply curve shifts to the right Both consumers and producers benefit Classical economics’ criticism:
Taxpayers pay Insulates producers from market signals
Price Floor (minimum price)
Price
Quantity
S0
P0
Q0
D0
P1
Q1
P1 is the minimum price allowed. The price cannot fall below that.
NB a floor price set below equilibrium will have no effect
Points to Note The minimum price can be set legally or by
having a marketing body that stockpiles At the higher price, consumers only want Q1, so
the quantity sold tends to decrease this would be less so if it was an inelastic
good Criticism
consumers buy less than they otherwise would
it sends the wrong market signal to producers
Surplus Production
Price
Quantity
S0
P0
Q0
D0
P1
Q1
Producers get the ‘signal’ to produce Q2, while consumers only want Q1
Q2
Surplus production
Surplus = Q2 - Q1
Government Intervention Aimed
at Consumers
Assistance for Consumers Product standard and safety laws ‘Truth in advertising’ laws Civil courts Australian Competition & Consumer
Council looks for anti-competitive behaviour standards and trade practices
Price Ceiling (maximum price)
Price
Quantity
S0
P0
Q0
D0
P1
Q1
P1 is the maximum price allowed. The price cannot rise above that.
NB a ceiling price set above equilibrium will have no effect
A Shortage in Production
Price
Quantity
S0
P0
Q0
D0
P1
Q1
Consumers want Q2 but producers get the ‘signal’ to produce Q1 so there will be an excess of demand (shortage).
Q2
Shortage
Shortage = Q2 – Q1
Criticisms of Intervention The problem of ‘rent-seeking’ by producers Lack of competition
Higher prices for consumers Collusion by small number of producers Inefficient allocation of resources Reduces pressure for innovation
Protection locks out developing countries
Market Deregulation Governments respond to the
classical criticisms
Microeconomic Reform Reduce tariffs Remove ‘non-tariff’ barriers Reduce direct & indirect subsidies Privatisation of govt enterprises Deregulate financial markets Competition ‘watchdogs’ & rules
Deregulation (removing a price floor)
Price
Quantity
S0
P1
Q1
D0
P0
Q0
If P0 is removed then the the ‘new’ price is P1 and the ‘new’ quantity is Q1
A Case Study of Labour Markets
Characteristics of labour markets Households supply labour The quantity is in hrs/wk, month or
year Firms demand labour The price is the wage rate/hr/mth/yr In the absence of regulation, the
wage rate is set by market signals the conjunction of supply and demand
Labour Market Intervention Maintain employment in certain regions Stop exploitation of ‘powerless’ workers Standard working conditions easier to
enforce Use minimum wages to boost household
income A form of income redistribution
Profits to wages
Some Possible Government Policies Subsidise/assist industry
to stimulate employment demand Increase value through education
etc supply side policies
Wage/training subsidies Minimum wage laws
Minimum Wage Policy
Price
Quantity
SL0
W0
QL0
DL0
W1
QL1
Unemployment (according to the classical view)
Price
Quantity
SL0
W0
QL0
DL0
W1
QL1
Workers want to supply QL2 hours while firms only want to emplyQL1 hours.
QL2
Unemployment?
No. of unemployed = QL2 – QL1
The Argument for Labour Market Deregulation…
Business wants to pay less in wages Government wants more people to be
employed BUT…LOWER WAGES DO NOT
ALWAYS LEAD TO LOWER UNEMPLOYMENT (this is discussed more in a later lecture)
Taxation and Markets
TaxationFOR AGAINST
Needed for government services
Income redistribution
Possible instrument of economic management
Disincentive for working hard
Disincentive for investment
Tax revenue ‘wasted’ by governments
A Tax
Price
Quantity
S0
P0
Q0
Increases price, reduces quantity sold
D0
Ptax
Qt
S1
Tax paid ($/unit)
P2
= Ptax- P2
A Tax
Price
Quantity
S0
P0
Q0
D0
Pt
Qt
S1
Total tax paid = (Pt- P2) x Qt
P2
The Distribution of the Tax Burden When a tax is imposed:
consumers pay more than they did, because of the higher price
producers receive less than they did because the reduction in quantity demanded effectively shifts them down the (S0) supply curve
Therefore, both consumers and producers ‘contribute’ to tax revenue
A Tax
Price
Quantity
S0
P0
Q0
D0
Pt
Qt
Stax
Consumer share of tax
P2
Producer share of tax
Points to note Consumers pay Pt − P0 more for the
good They pay total tax of (Pt − P0) x Qt
Producers receive P0 − P2 less for the good
They pay total tax of (P0 − P2) x Qt
Producer revenue is now P2 x Qt
A Tax Question If the equilibrium price was
$20/unit. A $6/unit tax is imposed and the
government receives $12,000/wk in tax revenue.
Producers revenue is now $36,000. What is the new price (with tax) of the unit?
What We Know
Price
Quantity
S0
20
Q0
D0
Pt
Qt
St
Govt. revenue = $12,000
P2
Producer revenue = $36,000
Tax/unit = $6 = Pt - P2
Govt revenue = Qt x $6 = $12,000/wk therefore Qt = 2000 units/wk
Producer revenue = $36,000 = Qt x P2
therefore 36,000 = 2000 x P2
therefore P2 = $18
Pt = P2 + tax rate
Pt = 18 + 6 = $24/unit = new price
Tax and Elasticity
Price
Quantity
S0
Q0
D0
Pt
Qt
Stax
Consumer contribution
P2
Producer contribution P0
Tax and Elasticity The more inelastic the good, the
more likely it is that consumers will ‘pay’ the greatest share of the tax burden.
The quantity does not fall as much so the producers are somewhat insulated from the effect.
Tax on an Elastic Good
Producer’s share of tax
Consumer’s share of tax
When demand is more elastic than supply, producers pay more of the tax
D
S0
St
Conclusions Whilst markets are usually a good
way to organise activity, governments do intervene.
Government policies may be aimed at assisting producers, consumers or both.
Government policies have an impact on prices and quantities.
In Light of the Objectives of the Lecture…
We now know: There are arguments for and against
government intervention in free markets When governments intervene, its policies
affect prices and quantities We can illustrate these effects and
determine, for example, who pays more of the particular tax.
Next Week Next Week’s Lecture:
Material Covered: Module Three Reading: Chapters Seven and Eight of Text
and Chapters Seven and Eight of Hakes and Parry
Topics: Macroeconomics Remember: Next Week’s Lecture is on
Thursday at 10.00 am in L209.
THE END