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Econ 100 Lecture 3.04

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

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Econ 100 Lecture 3.04

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  1. Econ 100Lecture 3.04 Government Policy & Economic Welfare 1-22-09

  2. 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

  3. 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

  4. 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

  5. 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.

  6. Figure 6.4 The Effect of a Per-Unit Tax on Laptop Sales

  7. Deadweight Loss Price Consumers Pay Pre-tax price Price Sellers Receive Reduction in Qty sold

  8. Deadweight Loss Retained CS Tax Rev From CS Tax Rev From CS Retained PS

  9. 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

  10. Elasticity and Tax Incidence • The incidence of a tax will be determined by the elasticities of demand and supply.

  11. Figure 6.5(a)Elasticity and Tax Incidence

  12. Figure 6.5(b)Elasticity and Tax Incidence

  13. 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.

  14. Figure 6.5(c)Elasticity and Tax Incidence

  15. Figure 6.5(d)Elasticity and Tax Incidence

  16. 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.

  17. 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

  18. Figure 6.9 The Effect of a Quota on the Market for Laptop Computers MV to Consumers DWL from CS DWL from PS MC of resources Quota Restriction Equilibrium Qs

  19. 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

  20. 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?

  21. 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?

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