econ 100 lecture 3.04
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Econ 100 Lecture 3.04. Government Policy & Economic Welfare 1-22-09. Evaluating the Impact of Government Intervention. Policy Instruments Available Taxes Typically: per-unit tax on output Others: lump-sum, value added (VAT) Subsidies Rebate on per-unit produced Price Floors - PowerPoint PPT PresentationTRANSCRIPT
Econ 100Lecture 3.04
Government Policy &
Economic Welfare
1-22-09
Evaluating the Impact of Government Intervention
• Policy Instruments Available– Taxes
• Typically: per-unit tax on output• Others: lump-sum, value added (VAT)
– Subsidies• Rebate on per-unit produced
– Price Floors• Minimum price that can be charged (e.g., minimum wage)
– Price Ceilings• Limit on the maximum price that can be charged (WIN)
– Quotas• Limits on amounts produced/imported • Infant industry/protectionism
How Do We Analyze the Effects of Taxes and Subsidies
• The efficient ideal market– “perfectly competitive” market
• Consumers and suppliers are price-takers, i.e. have no market power
Total Social Welfare
• Ideally the impact of a program should be evaluated as: {Pareto efficient}
– 1) can at least one person’s welfare be improved– 2) without making anyone worse off– http://en.wikipedia.org/wiki/Pareto_efficiency
• More realistically: Could the winners compensate the losers? {Pigouvian}
– Is the deadweight loss of the taxed good less than the surplus gain from the subsidized good?
– http://en.wikipedia.org/wiki/Pigovian_tax
Application: Taxes and Competitive Equilibrium
• Consider a per-unit tax, which adds a fixed dollar amount to each unit of a good sold.
– Graphically, the imposition of the tax is shown by a leftward shift of the supply curve.
Figure 6.4 The Effect of a Per-Unit Tax on Laptop Sales
Deadweight Loss
Price ConsumersPay
Pre-tax price
Price SellersReceive
Reduction inQty sold
Deadweight Loss
Retained CS
Tax RevFrom CS
Tax RevFrom CS
Retained PS
Application: Taxes and Competitive Equilibrium
• This example illustrates three key ideas related to taxes:
– Incidence of a tax on consumers:• The increase in price that consumers pay
– Incidence of a tax on producers:• The decrease in price producers receive
– Deadweight loss:• Losses in consumer and producer surplus that are not
transferred to the government as revenue
Elasticity and Tax Incidence
• The incidence of a tax will be determined by the elasticities of demand and supply.
Figure 6.5(a) Elasticity and Tax Incidence
Figure 6.5(b) Elasticity and Tax Incidence
Tax Incidence and Demand Elasticity
• If demand is inelastic, the majority of the tax incidence falls on consumers.
• If demand is elastic, the majority of the tax incidence falls on producers.
• As demand elasticity increases, the deadweight loss increases.
Figure 6.5(c) Elasticity and Tax Incidence
Figure 6.5(d) Elasticity and Tax Incidence
Tax Incidence and Supply Elasticity
• If supply is inelastic, the majority of the tax incidence falls on producers.
• If supply is elastic, the majority of the tax incidence falls on consumers.
• As supply elasticity increases, the deadweight loss increases.
Quotas
• Quota—A maximum quantity of a good or service that can be traded over a specific period of time.
– Used when the government determines the equilibrium quantity would not be in society's best interest
• For example: International trade
Figure 6.9 The Effect of a Quota on the Market for Laptop
Computers
Equilibrium Qs
Quota Restriction
DWL from CS
DWL from PS
MV to Consumers
MC of resources
The Effects of a Quota
• Quotas result in:– A transfer of surplus from consumers
to producers– Deadweight loss (DWL)
• DWL is due to less being produced than would be in an unrestricted (competitive) market
• Resources are underutilized and inefficiently allocated
– Consumers place a higher MV on good than MC of using resources to produce the good
The UW and Quotas
• The UW has recently announced that it will not accept any transfers for spring quarter– Restriction on number of students being admitted <->
quota• Assume that the market had previously been
efficient (Qs= Qd at current tuition fee)– A) what would be the economic consequences of the
transfer “freeze”?– B) what would be the impact of raising tuition, instead
of “freezing” transfers– C) In real-life, how are the students admitted to the
UW determined (by what kind(s) of allocation schemes?
A Take Home Problem
• It is estimated that illegal immigrants account for about 25% of construction labor in the US housing market– A) what would be the impact a ban on illegal
immigrants on the labor market for US housing construction, i.e., hourly wage rates?
– B) what would be the impact of this ban on the price of newly constructed houses?