Transcript Slide 1 - UCSB Economics

Taxes, MC pricing, and a
wrap-up of supply/demand
Today: Finishing the basic ideas
of supply and demand theory
From subsidies to taxes to MC
pricing
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Last time, we saw that a subsidy did not work
to help high rent in Isla Vista
Today, we talk more generally about a
negative subsidy, which is called a tax
After taxes, we will talk about MC pricing
Once these topics are done, we will spend the
remaining time reviewing Econ 1 thus far
Taxes
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Three major reasons to
charge taxes
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Revenue generation
The prevention of
harming the environment
or other people (see also
Externalities, Ch. 12)
Limitation of imports (see
also Trade, Ch. 9)
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Governor Arnold
Schwarzenegger
below
An example: A $1 tax on
flashlight suppliers
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Before tax:
Price is $8.80,
and 8
flashlights sold
An example: A $1 tax on
flashlight suppliers
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With tax:
Suppliers must
add $1 in
additional costs
for each
flashlight sold
An example: A $1 tax on
flashlight suppliers
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With tax:
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New equilibrium
price paid is
$9.20 by
consumers
New equilibrium
revenue kept by
suppliers, $8.20
An example: A $1 tax on
flashlight suppliers
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Who “pays” for
the tax?
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Consumers pay
$0.40 more than
before
Suppliers receive
$0.60 less than
before
What happens with a $1 tax?
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Summary
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Lower quantity sold
Consumers pay
more money per
unit sold
Sellers receive less
money per unit
sold
Deadweight loss
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Deadweight loss is economic surplus
that we lose by the imposition of a tax
To determine deadweight loss, we need
to find surplus and tax revenue
generated by tax
Any potential surplus not realized is
deadweight loss
Surplus and deadweight loss
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Consumer surplus
(top Δ)
Producer surplus
(bottom Δ)
Tax revenue
generated
(rectangle)
Deadweight loss
(right Δ)
Elasticity matters for
deadweight loss
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An example
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The smaller the price elasticity of supply,
the smaller the deadweight loss
See Figures 7.16 and 7.17 for visual
examples
Marginal cost pricing of public
services
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Governments often provide (or contract to a
private firm) some “essential” services to
residents
Back to MB = MC idea
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Remember 1st lecture
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Surplus is typically maximized when MB =
MC
Even though services are publicly
provided, MB = MC still applies
Example
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Electricity
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8 Mwh can be provided by coal @ 3¢/Kwh
20 Mwh can be provided by natural gas @
5¢/Kwh
10 Mwh can be provided by wind power @
9¢/Kwh
6 Mwh can be provided by solar power @
15¢/Kwh
Example
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8 Mwh (coal) @ 3¢/Kwh
20 Mwh (natural gas) @
5¢/Kwh
10 Mwh (wind power)
@ 9¢/Kwh
6 Mwh (solar power) @
15¢/Kwh
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Suppose that at a price
of 9¢/Kwh, 30 Mwh
were demanded
All coal capacity and
natural gas capacity can
be used, and 2 Mwh
provided by wind
MC pricing tells us to
charge 9 ¢/Kwh in order
to maximize surplus
Wrap-up and review of supply,
demand, and equilibrium
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We have talked
about many topics
related to supply,
demand, and
equilibrium thus far
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Utility
Surplus
Cost curves
Elasticity
Price controls
Taxes and subsidies
Voluntary incentives
Wrap-up and review of supply,
demand, and equilibrium
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In general, we have analyzed efficiency
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MB = MC principle
Some policies prevent MB = MC
principle, lowering efficiency
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Rent control
Taxes and subsidies
First-come, first-served
Wrap-up and review of supply,
demand, and equilibrium
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Many future topics build off of what we
have learned thus far
It is important to make sure that you
understand the foundation of
microeconomics, which we have
covered the last three weeks
Marginal analysis
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Remember that averages are
sometimes important in economics
Marginals are almost always important
Some later topics include why markets
sometimes fail
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Marginal analysis will continue to be
important
Supply, demand, and
equilibrium
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Remaining time today
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Your chance to ask questions before we
move on to more advanced topics
Review of key equations, tables, and
figures
Energy drinks
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# of drinks
Total benefit ($)
0
0
MB ($)
Avg. benefit 
N/A
5
1
5
5
3
2
8
4
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2.5
3
10.5
3.5
1.5
4
12
3
-1
5
11
2.2
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Cost is $2 per drink
We should buy the third
energy drink since
MB > MC
(2.5 > 2)
We should not buy the
fourth energy drink
since MB < MC
(1.5 < 2)
Note that we are NOT
maximizing avg. benefit
Supply and Demand
Shift in demand/Movement
along the supply curve
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The demand curve
shifted to the right
There is a
movement along the
supply curve, since
supply does not
change
MU of bananas: How many
would you eat if they were free?
Banana quantity
(bananas/hour)
Total utility
(utils/hour)
0
0
Marginal utility
(utils/banana)
70
1
70
50
2
120
30
3
150
10
4
160
-10
5
150
From individual demand…
…to market demand
CS from demand curves
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P = $3
Height of triangle is
($6 – $3), or $3.
Length of triangle is
(6 – 0), or 6
Area of triangle is
one-half times
length times height
CS = $9
The area of this
triangle is a good
approximation of
CS
Supply and profits
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At P1  positive
profits, since
TR > TC
(P  Q > ATC  Q)
At P2  negative
profits
At P3  firm shuts
down (TR is less
than VC for all Q)
Marginal analysis: Hire 4
workers/day if phones are $18
# of
empl./day
Phones per
day
Fixed cost
($/day)
Var. cost
($/day)
Total cost
($/day)
0
0
1000
0
1000
MC
($/phone)
5.00
1
20
1000
100
1100
4.00
2
45
1000
200
1200
10.00
3
55
1000
300
1300
12.50
4
63
1000
400
1400
20.00
5
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67
1000
500
1500
(Remember: Check shutdown condition)
Example of producer surplus
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When P = 25 per
unit, shaded area is
producer surplus
Area is a triangle,
one-half times
length times height:
0.5  10  25 =
125
Price elasticity of demand
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Calculated by the
percentage change in
quantity divided by
the percentage
change in price
%Q
Elasticity 
%P
Alternate version for straightline demand curves
Q / Q P Q P
1
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 
 
P / P Q P Q slope
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Slope on straight line is ΔP/ΔQ
Along a straight line, elasticity is also equal to
P/Q times inverse of the slope (see above)
Bumper crop of strawberries:
Not always good
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ε = 0.29  inelastic
Expenditure goes
DOWN moving from
S1 to S2
The bumper crop of
strawberries actually
hurts farmers
collectively
Long-run consequences of
rent control: Excess demand
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Notice that supplied
apartments for rent
are cut in half in the
long run with rent
control
Only 1/3 of the
people that want
apartments will get
them
($100s)
24
excess
demand
12
100s units
Price ceiling at G: Red
triangle is deadweight loss
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Total surplus is
trapezoid ADFE (at
most)
ΔCEF is potential
surplus that is never
gained
A $1 tax on flashlight suppliers

Who “pays” for
the tax?


Consumers pay
$0.40 more than
before
Suppliers receive
$0.60 less than
before
Surplus and deadweight loss
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Consumer surplus
(top Δ)
Producer surplus
(bottom Δ)
Tax revenue
generated
(rectangle)
Deadweight loss
(right Δ)