Transcript Choice, Change, Challenge, and Opportunity

Ch. 6: Markets in Action.
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Price ceiling and inefficiencies.
Price floors (minimum wage) and inefficiency.
Sales tax
Volatility of farm prices and revenues
How production subsidies and quotas influence
farm production, costs, and prices
The effect of price ceilings.
• Price ceiling is a “maximum” price.
• A price ceilinig is “binding” only if ceiling is
below equilibrium price.
• A binding price ceiling causes a shortage.
SR & LR effects without price ceiling
Suppose equilibrium price of gasoline is $4 and a
hurricane destroys numerous refineries. Examine
SR & LR effects on price and quantity.
S
$4
S-LR
D
Compare outcomes with and without a price ceiling
at $4
•Shortage
•Effect on consumer’s surplus
•Effect on producer’s surplus
•Deadweight loss
•Black markets, search costs, enforcement costs
S
$6
$5
$4
S-LR
D
100
200
Millions of gallons per day
Suppose the equilibrium price of gasoline is $5 after
the hurricane. Compared to the case where
government does not intervene, a price ceiling of $4
would cause
a) Both producers and consumers to be
worse off.
b) Producers to be worse off, but
consumers could be better or worse off.
c) Consumers to be worse off, but
producers could be better or worse off.
d) Consumers to be better off, but
producers to be worse off.
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Based on the diagram below, assuming no black
markets or search costs, a price ceiling of $4
would make consumers
25%
25%
25%
25%
a) $50 million better off
b) $50 million worse off
c) $100 million better off
d) $100 million worse off
$6
$50 million
better off
$50 million
worse off
$100 million
better off
$100 million
worse off
$5
$4
S-LR
D
0%
100
200
Millions of gallons per day
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Based on the diagram below, assuming no black
markets or search costs, a price ceiling of $4
would make prodcuers
25%
25%
25%
25%
a) $50 million better off
b) $50 million worse off
c) $150 million better off
d) $150 million worse off
$6
$50 million
be...
$50 million
wo...
$150 million
b...
$150 million
w...
$5
$4
S-LR
D
0%
100
200
Millions of gallons per day
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Suppose the equilibrium price of gasoline is $4 and
a hurricane wipes out some gasoline refineries. The
shortage caused by the price ceiling will be greater if
the demand for gasoline is
a) Both producers and consumers to be
worse off.
b) Producers to be worse off, but
consumers could be better or worse off.
c) Consumers to be worse off, but
producers could be better or worse off.
d) Consumers to be better off, but
producers to be worse off.
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Minimum Wage
• Is a price floor on labor.
• Why is there a minimum wage?
• Would a higher minimum wage make
workers better off?
• Efficiency versus equity
The Labor Market and the Minimum Wage
Minimum wage is
a price floor.
Price floor is
“binding” only if it
is above
equilibrium price.
The Labor Market and the Minimum Wage
A “binding” price floor
• reduces consumer
(employer) surplus
•Could increase or
decrease producer
(employee) surplus
•Creates a deadweight loss
• Destroys some of the
producer surplus
(employee) through search
activity.
The Effect of Price Floors
In general, a “binding” price floor will result in:
a. Buyers (employers) are worse off
b. Sellers (employees) could be better or worse off.
c. A deadweight loss.
S
$3
$2
a
b
c
f
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$1 d
D
500 1000 1500
Based on the diagram in the previous slide, if
a price floor is imposed at $3, there would be
of
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25%
so
f1
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25%
A
a surplus of 500
a surplus of 1000
A shortage of 500
A shortage of 1000
so
f5
. ..
a)
b)
c)
d)
0%
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Based on diagram in the previous slide, compared
to the case where there is no price floor, a price
floor of $3 would make sellers
a)
b)
c)
d)
No better or worse off
$250 better off
$750 worse off
$500 better off.
25%
No better or
w...
25%
$250 better
of...
25%
$750 worse off
25%
$500 better
of...
0%
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Based on diagram in the previous slide, compared
to the case where there is no price floor, a price
floor of $3 would make buyers
a)
b)
c)
d)
No better or worse off
$250 better off
$750 worse off
$500 worse off.
25%
No better or
w...
25%
$250 better
of...
25%
$750 worse off
25%
$500 worse
off...
0%
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Based on diagram in the previous slide, a price
floor of $3 would cause a deadweight loss of:
a)
b)
c)
d)
$0
$250
$500
$750
25%
$0
25%
25%
$250
$500
25%
$750
0%
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Taxes
• Tax Incidence
– the division of the burden of a tax between the buyer
and the seller.
– When an item is taxed, its price might rise by the full
amount of the tax, by a lesser amount, or not at all.
– If the price rises by the full amount of the tax, the
buyer pays the tax.
– If the price rises by a lesser amount than the tax, the
buyer and seller share the burden of the tax.
– If the price doesn’t rise at all, the seller pays the tax.
Taxes
• Tax Incidence
– Tax incidence doesn’t depend on tax law.
– The law might impose a tax on the buyer or
the seller, but the outcome will be the same.
– Example: On July 1, 2002, Mayor Bloomberg
upped the cigarette tax in New York City from
almost nothing to $1.50 a pack.
Tax Incidence
.
Taxes
• Tax incidence:
– Buyer: $1
– Seller : $.50
Taxes
• A Tax on Buyers
– suppose that
buyers, not
sellers, are taxed
$1.50 a pack.
• Tax incidence:
– Buyer: $1
– Seller: $.50
Tax Division and Elasticity of Demand
The more inelastic the demand, the larger is the
buyers’ share of the tax.
Taxes
The more elastic the supply, the larger is the
buyers’ share of the tax.
Income is lower on average among smokers in
Mexico than in the U.S. This means that the
consumers’ share of a tax on cigarettes would
likely be greater in Mexico.
a) True
b) False
50%
50%
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The supply of apples is highly inelastic in the
short run. Consequently, any tax on apples
will be borne primarily by
50%
50%
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a) Apple producers
b) Apple buyers.
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Taxes
• Taxes in Practice
– Taxes usually are levied on goods and
services with an inelastic demand or an
inelastic supply.
– Alcohol, tobacco, and gasoline have inelastic
demand, so the buyers of these items pay
most the tax on them.
– Labor has a low elasticity of supply, so the
seller—the worker—pays most of the income
tax and most of the Social Security tax.
Taxes
•
Taxes create allocative
inefficiency unless S or D
is perfectly inelastic.
• What’s effect of tax on
1.
2.
3.
4.
•
Consumer surplus
Producer surplus
Tax revenue
Deadweight loss
Excess burden of tax
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reduction in consumer &
producer surplus minus tax
revenue
Identical to deadweight loss
Consider the market for insulin. Suppose demand
is perfectly inelastic, equilibrium price per dose is
$10, and equilibrium quantity is 1 million per year.
If a $2 tax is imposed on each dose, the annual tax
revenue would be
a) $2 million
b) Less than $2
million
c) More than $2
million.
0%
33%
$2 million
33%
Less than $2 m...
33%
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More than $2 m...
Consider the market for insulin described above.
A $2 tax would cause consumer’s surplus to ____.
a) Not change
b) Decrease $2
million
c) Decrease by less
than $2 million.
33%
33%
33%
0%
Not change
Decrease $2 mi...
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Decrease by le...
Consider the market for insulin described above.
A $2 tax would cause producer’s surplus to
____.
a) Not change
b) Decrease $2
million
c) Decrease by less
than $2 million.
33%
33%
33%
0%
Not change
Decrease $2 mi...
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Decrease by le...
Subsidies and Quotas
– Fluctuations in the weather bring big
fluctuations in farm output.
– How do changes in farm output affect the
prices of farm products and farm revenues?
– How might farmers be helped by intervention
in markets for farm products?
Stabilizing Farm Revenues
– A poor harvest
decreases supply.
 Effect on total
revenue?
• higher price
• lower quantity
 How would answer
change if demand
were elastic?
Stabilizing Farm Revenues
– A large harvest
increases supply.
– Effect on total
revenue?
• Lower price
• Higher quantity
– How would answer
change if demand
were elastic?
Stabilizing Farm Revenues
Intervention in markets for farm products takes
two main forms:
 Subsidies
a payment made by the government to a producer
that’s in addition to market price received.
 Production quotas
an upper limit on the quantity of a good that may be
produced during a specified period.
Subsidies
Effect of $20 subsidy
• Equilibrium quantity
• Equilibrium price
• Consumer surplus
• Producer surplus
• Cost to taxpayers
• Deadweight loss
The $20 subsidy would cause
consumers to be
a)
b)
c)
d)
$500 million better off
$600 million better off
$400 million better off
$400 million worse
off
25%
25%
25%
25%
0%
$500 million
better off
$600 million
better off
$400 million
better off
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$400 million
worse off
The $20 subsidy would cause
producers to be
a)
b)
c)
d)
$500 million better off
$600 million better off
$400 million better off
$400 million worse
off
25%
25%
25%
25%
0%
$500 million
better off
$600 million
better off
$400 million
better off
30
$400 million
worse off
The $20 subsidy would cost taxpayers
a)
b)
c)
d)
$1000 million
$1200 million
$500 million
$600 million
25%
25%
25%
25%
0%
$1000 million
$1200 million
$500 million
30
$600 million
Quotas
• Maximum production
allowed.
• Binding only if below equil
quantity
• limits total production to 40
million tons a year.
• Effect on
– Price
– Consumer’s surplus
– Producer’s surplus
– Deadweight loss
– Price of license
Suppose that a “binding” quota on
peanuts is imposed. This will
a) Make consumers worse off, but
producers better off.
b) Make consumers worse off, but
producers could be better or
worse off.
c) Make both consumers and
producers worse off.
d) Make both consumers and
producers better off.
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Markets for Illegal Goods
• How do increased penalties on sellers
affect price, quantity?
• How do increased penalties on buyers
affect price, quantity?
• Illegal immigration?