Transcript Document

American Government
Micro-Economics
What is the
economic problem?
Providing for people’s
wants and needs in a
world of scarcity
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2
What is meant by
scarcity?
The condition in which
wants are forever greater
than the available supply
of time, goods, and
resources
3
What does scarcity
force us to do?
It forces us to
make choices
4
What are resources?
The basic categories of
inputs used to
produce goods and
services
5
What are the three
categories of
resources?
Land
Labor
Capital
6
What is a
land resource?
A shorthand expression
for any natural resource
provided by nature
7
What is labor?
The mental and physical
capacity of workers to
produce goods and services
8
What is
entrepreneurship?
The creative ability of
individuals to seek profits
by combining resources
to produce innovative
products.
9
What is capital?
The physical plants,
machinery, and
equipment used to
produce other goods
10
Land
Labor
Capital
Entrepreneurship organizes
resources to produce goods
and services
11
What is economics?
The study of how
society chooses to
allocate its scarce
resources to the
production of goods
and services in order to
satisfy unlimited wants
12
What is
macroeconomics?
The branch of economics
that studies decisionmaking for the economy
as a whole
13
What is
microeconomics?
The branch of economics
that studies decisionmaking by a single
individual, household,
firm, industry, or level of
government
14
What are the three
fundamental economic
questions?
What to produce?
How to produce?
For whom to produce?
What is
opportunity cost?
The best alternative
sacrificed for a
chosen alternative
What opportunity cost am
I experiencing now?
The most money that you
could be making if you were
somewhere else instead of
studying these slides
Can opportunity cost
be something other
than money?
Yes! That most desired
activity that you are
presently giving up
is considered an
opportunity cost
What is a production
possibilities curve?
A curve that shows the
maximum combinations of
two outputs that an
economy can produce,
given its available
resources and technology
What is technology?
The body of knowledge
and skills applied to how
goods are produced
What assumptions
underlie the productions
possibilities model?
• Fixed resources
• Fully employed resources
• Technology unchanged
What is the conclusion
of the production
possibilities curve?
Scarcity limits an
economy to points on
or below its production
possibilities curve
What is the law of
increasing
opportunity costs?
The principle that the
opportunity cost
increases as
production of one
output expands
What is
economic growth?
The ability of an economy
to produce greater levels
of output, an outward
shift of its production
possibilities curve
What makes possible
economic growth?
Research and development
of new technologies
Increase production in
excess of worn out capital
What happens when a
country does not invest in
new technology?
Everything else being equal,
the country will not grow
What is investment?
The accumulation of
capital, such as factories,
machines, and inventories,
that is used to produce
goods and services
What is the opportunity
cost of investment?
The consumer goods that
could have been
purchased with the
money spent for plants
and other capital
What does an increase
in investments make
possible in the future?
Economic growth and
more goods and
services
What conclusion can we
make about investments?
A nation can accelerate
growth by increasing
production of capital
goods in excess of the
capital being worn out
Why do countries trade?
International trade allows
a country to consume a
combination of goods
and services that
exceeds its production
possibilities curve
U.S. Production and Consumption
80
70
60
40
20
0
Grain (tons per year)
100 A
B´ (with trade)
B (without trade)
PPC
U.S.
Steel (tons per day)
C
10
20
30
40
50
80
60
Grain (tons per year)
100
D
40
30
20
0
Japanese Production
and Consumption
E (without trade)
E´ (with trade)
PP
Japan
C
Steel (tons per day)
10
20
30
F
40
50
Why should countries
specialize and trade?
Total world output
increases, and therefore,
the potential for greater
total world consumption
also increases
If countries should
specialize, in what should
they specialize?
They should produce
those goods and services
in which they have a
comparative advantage
What is
comparative advantage?
The ability of a country
to produce a good at a
lower opportunity cost
than another country
What is Absolute Advantage?
• When one country produces a good or
service using fewer resources.
What is the
law of demand?
The principle that there is an
inverse relationship
between the price of a good
and the quantity buyers are
willing to purchase in a
defined time period, ceteris
paribus
What does “ceteris
paribus” mean?
All else remains the same
What is a
demand curve?
Depicts the relationship
between price and
quantity demanded
Individual’s Demand Curve for Compact Discs
P
$20
$15
Individuals Buyer’s Demand Schedule for Compact Discs
A
B
C
$10
Point
Price
per compact disk
A
B
C
D
$20
$15
$10
$5
Quantity demanded
(per year)
4
6
10
16
7
D
$5
Demand Curve
4
8
12 16
Q
Why do demand curves
have a negative slope?
At a higher price consumers
will buy fewer units, and at
a lower price they will buy
more units
What is a
demand schedule?
Shows the specific
quantity of a good or
service that people are
willing and able to buy at
different prices
What is
market demand?
The summation of the
individual demand
schedules
IMPORTANT - KNOW
THE DIFFERENCE
BETWEEN A CHANGE
IN THE QUANTITY
DEMANDED AND A
CHANGE IN DEMAND
When price changes,
what happens?
The curve does not shift
- there is a change in
the quantity demanded
Increase in
Quantity
Demanded
Decrease in
Price
P
$20
$15
Fred’s Demand Curve
$10
$5
D1
1 2 3 4 5 6 7 8 9 Q
P
$20
$15
Mary’s Demand Curve
$10
$5
D2
1 2 3 4 5 6 7 8 9 Q
P
Market Demand Curve
$20
$15
$10
$5
D3
Q
3 4 5 6 7 8 9 101112
P
$20
$15
Fred’s Demand Curve
$10
P
$20
$15
Mary’s Demand Curve
$10
$5
1 2 3 4 5 6 7 8 9 Q
12
P
D2
$5
D1
1 2 3 4 5 6 7 8 9 Q
13
Market Demand Curve
$20
$15
$10
$5
D3
Q
3 4 5 6 7 8 9 10 11 12
14
Market Demand Schedule for Compact Discs
Price
$25
$20
$15
$10
$5
Fred
Mary
Total Demanded
1 + 0 =
2
1
3
3
4
5
5
7
1
3
6
9
12
P
$20
$15
$10
$5
A change in price causes a
change in the quantity demanded
A
B
D
Q
10 20 30 40 50
When something
changes other than
price, what happens?
The whole curve
shifts,there is a
change in demand
P
$20
$15
When the ceteris paribus assumption
is relaxed, the whole curve can shift
A
$10
B
D
D2
$5
10 20
1
Q
30 40 50
Increase
in demand
Change in
nonprice
determinant
What can cause a shift
in a demand curve?
• Tastes and preferences
• Number of buyers in the market
• Income
• Expectations of consumers
• Prices of related goods
Decrease in
quantity
demanded
Upward
movement
along the
demand curve
Price
increases
Increase in
quantity
demanded
Downward
movement
along the
demand curve
Price
decreases
Decrease or
increase in
demand
Leftward or
rightward shift in
the demand curve
Nonprice
determinant
What is a normal
good?
Any good for which
there is a direct
relationship between
changes in income and
its demand curve
What is an
inferior good?
Any good for which
there is an inverse
relationship between
changes in income and
its demand curve
What are
substitute goods?
Goods that compete
with one another for
consumer purchases
What happens when the
price increases for a
good that has a
substitute?
The demand curve for
the substitute good
increases
What happens when the
price decreases for a
good that has a
substitute?
The demand curve for the
substitute good
decreases
What does a direct
relationship between
price and quantity
mean?
The two move in the
same direction
What are complementary
goods?
Goods that are
jointly consumed
with another good
What happens when the
price increases for a
good that has a
complement?
The demand curve for
the substitute good
decreases
What happens when the
price decreases for a
good that has a
complement?
The demand curve for
the substitute good
increases
What does an inverse
relationship between
price & quantity mean?
It means that the two
move in opposite
directions
What is the
law of supply?
The principle that there is
a direct relationship
between the price of a
good and the quantity
sellers are willing to offer
for sale in a defined time
period, ceteris paribus
Why do supply curves
have a positive slope?
Only at a higher price will it
be profitable for sellers to
incur the higher opportunity
cost associated with
supplying a larger quantity
P
$20
A company’s
Supply Curve for
Compact Discs
$15
Supply Curve
A
B
$10
C
$5
10
20
30
40
Q
An Individual Seller’s Supply for Compact Discs
Point
A
B
C
Price
$20
10
6
Quantity
40
30
20
P
Super Sound Supply Curve
S1
$25
$20
$15
$10
10 15 20 25
Q
P
High Vibes Supply Curve
S2
$25
$20
$15
$10
20 25 30 35
Q
What is a market?
Any arrangement in which
buyers and sellers
interact to determine the
price and quantity of
goods and services
exchanged
What is market supply?
The horizontal summation of
all the quantities supplied at
various prices that might
prevail in the market
P
$25
$20
$15
$10
Market Supply Curve
S total
40 45 55 60
Q
Market Supply Schedule for Compact Discs
Price
$25
$20
$15
$10
$5
Super Sound
High Vibes
Total
25 + 35 =
20
30
15
25
10
20
5
15
60
50
40
30
20
IMPORTANT - KNOW
THE DIFFERENCE
BETWEEN A CHANGE
IN THE QUANTITY
SUPPLIED AND A
CHANGE IN SUPPLY
When price changes,
what happens?
The curve does not shift there is a change in the
quantity supplied
P
$20
A change in price
causes a change
in the quantity
supplied
$15
Supply Curve
A
B
$10
C
$5
10
20
30
40
Q
Increase in
Quantity
Supplied
Increase in
Price
When something
changes other than
price, what happens?
The whole curve shifts there is a change in supply
P
$20
When the ceteris paribus
assumption is relaxed, the
whole curve can shift
S1
$15
S2
$10
$5
10
20
30
40
Q
Increase
in supply
Change in
nonprice
determinant
What can cause a shift
in a supply curve?
1. Number of sellers in the market
2. Technology
3. Resource prices
4. Taxes and subsidies
5. Expectations of producers
6. Prices of other goods the firm
could produce
The Supply & Demand
for Tennis Shoes
P
$120
$90
S
Surplus
$60
$30
Shortage
D
1,000 2,000 3,000 4,000
Q
What is an equilibrium?
A market condition that
occurs at any price for
which the quantity
demanded and the
quantity supplied are equal
What is the
price system?
A mechanism that uses
the forces of supply
and demand to create
an equilibrium through
rising and falling prices
What can cause a shift
in a demand curve?
• Tastes and preferences
• Related good prices
• # Buyers in the market
• Income
• Expectations of consumers
P
The Effects of Shift in Demand
on Market Equilibrium
$1200
S
$900
Shortage
$600
$300
D1
4
8
12
16
D2
Q
The Effects of Shift in Demand
on Market Equilibrium
$40
S
$30
Surplus
$20
$10
D1
D2
10
20
30
40
Increase in
Quantity
Supplied
Increase in
Equilibrium
Price
Increase in
Demand
Decrease in
Quantity
Supplied
Decrease in
Equilibrium
Price
Decrease
in Demand
What can cause a shift
in a supply curve?
• Resource prices
• Other Goods the company can
make (prices)
• Technology
• Taxes and subsidies
• Expectations of producers
• Number of sellers in the market
The Effects of Shift in Supply
on Market Equilibrium
$4
S1
$3
Surplus
S2
$2
$1
D
20
40
60
80
The Effects of Shift in Supply
on Market Equilibrium
$800
S2
$600
S1
Shortage
$400
$200
D
2
4
6
8
Increase in
Quantity
Demanded
Decrease in
Equilibrium
Price
Increase in
Supply
Decrease in
Quantity
Demanded
Increase in
Equilibrium
Price
Decrease
in Supply
Can the laws of demand
and supply be repealed?
In some markets, the
objective of politicians
is to prevent prices
from reaching the
equilibrium price
What are the two types
of price controls?
Price ceilings
Price floors
What is a price ceiling?
A legally established
maximum price a
seller can charge
P
Rent Control Results in a
Shortage of Rental Units
S
$800
$600
$400
Rent ceiling
Shortage
D
$200
2
4
6
8
Q
Shortage
Quantity Demanded
exceeds the
quantity supplied
Rent
Ceiling
What is the purpose of
price ceilings on rent?
So needy people will
pay lower rent than
the equilibrium rent
Why may rent controls
be counterproductive?
• Shortages
• Illegal markets
• Less maintenance
• Discrimination
What are other
examples of price
ceilings?
Wage and price controls
Usury laws
What is a price floor?
A legally established
minimum price a
seller can be paid
A Minimum Wage Results in
a Surplus of Labor
Wm
S
Minimum wage
Unemployment
We
D
QD
QE
QS
Unemployment
Minimum
wage
What are examples of
price floors?
Minimum wage law
Agricultural price supports
Why do we have price
ceilings and floors?
Because of failures in
the free market
What is market failure?
A situation in which the
price system creates a
problem for society or fails
to achieve society’s goals
Who was Adam Smith?
The father of modern
economics who wrote
The Wealth of Nations,
published in 1776
What did Adam Smith
say about competition?
There must be competition
for markets to function
properly
What happens when
competition is lacking?
Market failure results
Rigging the Personal Computer Market
$2500 Inefficient equilibrium
$2000
S2
S
1
$1500
$1000
$500
Efficient equilibrium
D
50 100 150 200 250 300
What is an example of
another market failure?
Externalities
What is an externality?
A cost or benefit imposed
on people other than the
consumers and producers
of a good or service
What is a
negative externality?
An externality that is
detrimental to third parties
What is an example of a
negative externality?
Pollution
External Cost of Pollution
Includes external costs of pollution
S2 S
1
P2
P1
D
Excludes external costs of pollution
Q2
Q1
What is a
positive externality?
An externality that is
beneficial to third parties
What is an example of a
positive externality?
Vaccinations
External Benefits of AIDS Vaccinations
Includes Vaccination benefits
S
P2
P1
D2
$10
Excludes Vaccination benefits
Q1
Q2
D1
Inefficient
equilibrium
External
costs
Inefficient
equilibrium
External
benefits
What is another
example of a positive
externality?
Public goods
What is a public good?
A good that, once produced,
has two properties:
(1) users collectively
consume benefits
(2) no one can be excluded
What are examples of
public goods?
• National defense
• Public education
• Roads
What is another
example of market
failure?
Income inequality
8.1 TAXES ON BUYERS AND
SELLERS
• Tax Incidence
–Tax incidence
–The division of the burden of a tax between
the buyer and the seller.
–When a good is taxed, it has two prices:
• A price that includes the tax
• A price that excludes the tax
–Buyers respond to the price that includes the
tax.
–Sellers respond to the price that excludes the
tax.
8.1 TAXES ON BUYERS AND
SELLERS
–The tax is like a wedge between the two
prices.
– Suppose that the government puts a $10 tax
on MP3 players.
–How does the price that buyers pay change?
–How does the price sellers receive change?
–How is the burden of a tax shared between the
buyer and the seller?
8.1 TAXES ON BUYERS AND
SELLERS
Figure 8.1(a) shows what
happens when the
government taxes buyers
of the MP3 players.
1. With no tax, the
price is $100 and
5,000 players a
areonbought.
2. week
A $10 tax
buyers of
MP3 players shifts the
demand curve to D – tax.
8.1 TAXES ON BUYERS AND
SELLERS
3. The price paid by
buyers rises to
$105—an increase
4. The
price
received by
of $5
a player.
sellers falls to $95—a
decrease of $5 a player.
5. The quantity decreases
to 2,000 players a week.
6. The government’s tax
revenue is $20,000 a
week.
8.1 TAXES ON BUYERS AND
SELLERS
Figure 8.1(b) shows what
happens when the
government taxes sellers
of the MP3 players.
1. With no tax, the
price is $100 and
5,000 players a
areonbought.
2. week
A $10 tax
sellers of
MP3 players shifts the
supply curve to S + tax.
8.1 TAXES ON BUYERS AND
SELLERS
3. The price paid by
buyers rises to
$105—an increase
4. The
price
received by
of $5
a player.
sellers falls to $95—a
decrease of $5 a player.
5. The quantity decreases
to 2,000 players a week.
6. The government’s tax
revenue is $20,000 a
week.
8.1 TAXES ON BUYERS AND
SELLERS
Taxes and Efficiency
– A tax places a wedge between the buyers’
price (marginal benefit) and the sellers’ price
(marginal cost).
– The equilibrium quantity is less than the
efficient quantity and a deadweight loss
arises.
8.1 TAXES ON BUYERS AND
SELLERS
Figure 8.2 shows the
inefficiency of taxes.
In Figure 8.2(a), the market
is efficient with marginal
benefit equal to marginal
cost.
Total surplus—the sum of
2. Consumer surplus and
3. Producer surplus—is
maximized.
8.1 TAXES ON BUYERS AND
SELLERS
Figure 8.2(b) shows
how taxes create
A
$10 tax shifts the supply
inefficiency.
curve to S + tax.
1. Marginal benefit exceeds
2. Marginal cost.
3. Consumer surplus and
4. Producer surplus shrink.
5. The government collects
its tax revenue.
6. A deadweight loss arises.
8.1 TAXES ON BUYERS AND
SELLERS
The loss of consumer
surplus and producer
surplus is the burden of
the tax.
The burden of the tax
equals the tax revenue
plus the deadweight
loss.
8.1 TAXES ON BUYERS AND
SELLERS
– Excess burden
– The deadweight
loss from a tax—
the amount by
which the burden
of a tax exceeds
the tax revenue
received by the
– The
excess
government.
burden is
$15,000.
– (3,000  $10  2)
8.1 TAXES ON BUYERS AND
SELLERS
• Incidence, Inefficiency, and Elasticity
–The incidence of a tax and its excess burden
depend on the elasticites of demand and
supply:
• For a given elasticity of supply, the buyer pays a
larger share of the tax the more inelastic is the
demand for the good.
• For a given elasticity of demand, the seller pays a
larger share of the tax the more inelastic is the
supply of the good.
8.1 TAXES ON BUYERS AND
SELLERS
• Tax Incidence and Elasticity of Demand
– Perfectly Inelastic Demand: Buyer Pays and
Efficient
– Perfectly Elastic Demand: Seller Pays and
Inefficient
– Figures 8.3(a) and 8.3(b) illustrate these two
extreme cases.
8.1 TAXES ON BUYERS AND
SELLERS
– Figure 8.3(a) shows
tax incidence in a
market with perfectly
inelastic demand—the
market
insulin.
A tax
of 20¢for
a dose
raises
the price by 20¢, and the
buyer pays all the tax.
Marginal benefit equals
marginal cost, so the
outcome is efficient.
8.1 TAXES ON BUYERS AND
SELLERS
– Figure 8.3(b) shows
tax incidence in a
market with perfectly
elastic demand—the
A tax
of 10¢for
a pink
market
pinkpen
pens.
lowers the price received
by the seller by 10¢, and
the seller pays all the tax.
A deadweight loss arises, so
the outcome is inefficient.
8.1 TAXES ON BUYERS AND
SELLERS
• Tax Incidence, Inefficiency, and Elasticity
of Supply
– Perfectly Inelastic Supply: Seller Pays and
Efficient
– Perfectly Elastic Supply: Buyer Pays and
Inefficient
– Figures 8.4(a) and 8.4(b) illustrate these two
extreme cases.
8.1 TAXES ON BUYERS AND
SELLERS
– Figure 8.4(a) shows
tax incidence in a
market with perfectly
inelastic supply—the
A tax
of 5¢ for
a bottle
does not
market
spring
change
water.the price paid by the
buyer but lowers the price
received by the seller by 5¢.
Marginal benefit equals
marginal cost, so the
outcome is efficient.
The seller pays the entire tax.
8.1 TAXES ON BUYERS AND
SELLERS
– Figure 8.4(b) shows
tax incidence in a
market with perfectly
elastic supply—the
A tax
of 1¢ for
a pound
market
sand.
increases the price by 1¢ a
pound, and the buyer pays
all the tax.
A deadweight loss arises, so
the outcome is inefficient.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
The Personal Income Tax
–In 2004, the personal income tax raised:
•More than $1 trillion for the federal government
•About $300 billion for state and local governments
–The amount of income tax that a person pays
depends on her or his taxable income and on the
tax rates.
–Taxable income
–Total income minus a personal exemption and
a standard deduction (or other allowable
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
–
–Marginal tax rate
–The percentage of an additional dollar of
income that is paid in tax.
–Average tax rate
–The percentage of income that is paid in tax.
8.2 INCOME AND SOCIAL
THE
TAX SYSTEM
SECURITY
TAX
–A tax can be progressive, proportional, or
regressive.
–Progressive tax
–A tax whose average rate increases as
income increases.
–Proportional tax
–A tax whose average rate is constant at all
income levels.
–Regressive tax
–A tax whose average rate decreases as
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
Figure 8.5 shows
U.S. tax rates in
2001.
1. Marginal tax
rate increases
with income.
2. Average tax rate
increases with
income
The personal
income tax is a
progressive tax.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
The Effects of the Income Tax
–Tax on Labor Income
–Firms can substitute machines for labor, so the
demand for labor is elastic.
–Most people must work for their income, so the
supply of labor is inelastic.
–With elastic demand and inelastic supply, the
worker bears the greater burden of the income
tax.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
Figure 8.6 shows the
effects of a tax on labor
With
a 20% income tax:
income.
1. The supply of labor
decreases, the wage rate
rises, and the after-tax wage
rate falls.
2. The employer pays some of
the tax.
3. The worker pays most of the
tax.
4. A deadweight loss arises.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
–Taxes on Capital Income
–Taxing the income from capital works like
taxing the income from labor.
–One crucial difference: capital is internationally
mobile and so the supply of capital is highly
elastic—perhaps perfectly elastic.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
Figure 8.7 shows the
effect of a tax on capital
1.
The supply of capital is
income.
perfectly elastic.
2. With a 40 percent tax on
capital income, the interest
rate rises.
3. The firm pays the entire tax.
4. A large deadweight loss
arises.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
–Taxes on Income from Land and Unique
Resources
–Works in the same way as taxing the income
from other sources except for one crucial
difference.
–The supply of land is highly inelastic.
–The tax on land income is fully borne by the
landowners and the quantity of land is
unaffected by the tax.
–With no change in the quantity of land, the tax
on land income creates no deadweight loss or
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
Figure 8.8(a) shows a
tax on income from
land.
1. Supply is perfectly inelastic.
2. With a 40 percent tax, the
supply of land is
unchanged and the market
rent is unchanged.
3. The landowner pays the
entire tax.
No deadweight loss
arises—the tax is efficient.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
Figure 8.7 (b) shows a high
tax rate on Barbara
Walter’s income.
1. Supply is perfectly inelastic.
2. With a 40 percent tax, the
supply curve is unchanged and
the market price is unchanged.
3. Barbara Walters pays the entire
tax.
No deadweight loss arises and
the tax is efficient.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
• The Social Security Tax
The Social Security tax law says that the tax is to be
shared equally by workers and employers.
But the principles that determine the incidence of other
taxes you’ve studied in this chapter also apply to the
Social Security tax.
We look at two extreme Social Security taxes: one on
workers only and one on employers only.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
–A Social Security
Tax on Workers
– With no taxes, the
wage rate is $6.00
an hour and 4,000
people are
1. A
20 percent Social
employed.
Security tax on workers
shifts the supply curve
to LS + tax.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
– 2. The wage rate
paid by employers
rises to $6.25 an
hour—an increase
of 25
centsofanpeople
3. The
number
hour.
employed
decreases
to 3,000.
4 Workers receive $5
an hour—a decrease
of $1 an hour.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
– 5. The government
collects tax
revenue shown by
the purple
Workers
pay most of
rectangle.
the tax because the
supply of labor is more
inelastic than the
demand for labor.
8.2 INCOME AND SOCIAL
SECURITY TAX
–A Social Security Tax
on Employers
Payroll tax
A tax on employers based on the wages they pay
their workers.
Figure 7.4 on the next slide shows the effects of a
payroll tax.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
–A Social
Security Tax on
Employers
With no tax, the
wage rate is $6.00
an hour and 4,000
people are
employed.
1. A tax on employers of
$1.25 an hour shifts
the demand curve to
LD – tax.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
2. The wage rate falls
to $5.00 an hour—a
decrease of $1.00 an
hour.
3. The number of
workers employed
decreases to 3,000.
8.2 INCOME TAX AND SOCIAL
SECURITY TAX
4. Employers’ total cost
of labor rises to $6.25
an hour—the $5.00
wage rate plus the
$1.25 payroll tax.
5. The government
collects tax revenue
shown by the purple
rectangle.
8.3 FAIRNESS AND THE BIG
TRADEOFF
–Whenever political leaders debate tax issues,
it is fairness, not efficiency, that looms above all
other considerations.
–There are two conflicting principles of fairness
of taxes:
• The benefits principle
• The ability-to-pay principle
8.3 FAIRNESS AND THE BIG
TRADEOFF
•The Benefits Principle
– Benefits principle
– The proposition that people should pay taxes
equal to the benefits they receive from public
goods and services.
–This arrangement is fair because it means that
those who benefit most pay the most.
–But to implement it, we would need an objective
way of measuring each person’s marginal
benefit from public goods and services.
8.3 FAIRNESS AND THE BIG
TRADEOFF
•The Ability-to-Pay Principle
–Ability-to-pay principle
– The proposition that people should pay taxes
according to how easily they can bear the
burden.
–A rich person can more easily bear the burden
of providing public goods than a poor person
can, so the rich should pay higher taxes than
the poor.
–This principle compares people according to
• Horizontal equity
• Vertical equity
8.3 FAIRNESS AND THE BIG
TRADEOFF
Horizontal equity
The requirement that taxpayers with the same ability
to pay the same taxes.
Vertical equity
The requirement that taxpayers with a greater ability
to pay bear a greater share of the taxes.
8.3 FAIRNESS AND THE BIG
TRADEOFF
The Marriage Tax Problem
• In the U.S. tax code, a married couple is
considered a single taxpayer.
• This arrangement means that if they each earn the
same income as before a marriage, the married
couple might pay more tax than they did before
marriage.
8.3 FAIRNESS AND THE BIG
TRADEOFF
•The Big Tradeoff
–Questions about the fairness of taxes conflict
with efficiency questions and create the big
tradeoff.
–Taxes on capital incomes create the greatest
deadweight loss—are the most inefficient.
–But most of the capital is owned by a small
number of rich people, so (most people believe)
taxes on capital are the fairest.
–Our tax system is an evolving attempt to juggle
Taxes in YOUR Life
• The Tax Foundation has calculated “Tax
Freedom Day”—
• the day by when the average U.S. citizen
has worked long
• enough to pay a year’s tax bill.
• In 2004, Tax Freedom Day was 17 April—
107 days:
•
•
•
•
•
38 days to pay personal income taxes
30 days to pay Social Security taxes
16 days to sales and excise taxes
11 days to pay property taxes
9 days to pay corporate income taxes