ECON 2100 Principles of Microeconomics (Fall 2018) Government Policies in Markets: Price Controls and Per Unit Taxes

Transcription

1 ECON 21 Princiles of icroeconomics (Fall 218) Government Policies in arkets: Price Controls and Per Unit axes Relevant readings from the textbook: ankiw, Ch. 6 Suly,, and Government Policies ankiw, Ch. 8 Alication: the Costs of axation Suggested roblems from the textbook: Chater 6 Quick Quiz ultile Choice (Pages ): 2, 3, 4, 5, and 6 Chater 6 Questions for Review (Pages ): 1, 2, 4, 5, 6, and 7 Chater 6 Problems and Alications (Pages ): 1, 3, 4, 5, 6, and 1 Chater 8 Quick Quiz ultile Choice (Page 164): 2 and 6 Chater 8 Questions for Review (Page 165): 1, 2, 3, and 5 Chater 8 Problems and Alications (Pages ): 1, 2, 6, 7, 9 and 1 Definitions and Concets: Price Control legal restriction on the rice at which trade can take lace. Price Ceiling a maximum legal rice at which trade can take lace. Price Floor a minimum legal rice at which trade can take lace. Possible motives for imlementing rice controls : (i) o either increase or decrease the rice at which a articular good is traded (in an attemt to make the resulting rice better for articiants on one articular side of the market) (ii) o maniulate the overall level of overall rices in an economy (i.e., to combat inflation ) Examles of rice controls in the U.S.: (i) rent controls intended to make housing more affordable for renters in some major metroolitan areas (rice ceiling => intended to imrove the outcome for consumers of housing); minimum wage laws intended to give low wage workers higher wage rates (rice floor => intended to imrove the outcome for sellers of labor) (ii) rice controls imosed in an attemt to revent the overall rice level form rising too quickly during WW-I, WW-II, Korean War, and during Nixon Administration Nixon s Price Controls imlemented from : Administered by the Cost of Living Council By 1973 shortages were artificially created in many markets: ranchers stoed shiing cattle to markets; farmers drowned chickens; suermarket shelves were emtied System finally abolished in George Shultz (head of the Office of anagement and Budget ) commented to Nixon that, At least we have now convinced everyone else of the rightness of our original osition that wage-rice controls are not the answer.

2 Per Unit ax (or Quantity ax ) a tax under which either: buyers have to ay a certain amount to the government for every unit urchased, or sellers have to ay a certain amount to the government for every unit sold (e.g., total er unit taxes on gasoline of roughly $.628 er gallon) Possible motives for imosing a er unit tax on a good: (i) Generate tax revenue for the government. (ii) Discourage trade of the good. Incidence of a ax a measure of who bears the burden of the tax in terms of decreased welfare. Per Unit ax Imosed on Buyers => Effected => at the oint of sale any buyer is now willing to ay exactly $ less than before => curve shifts down by $ Per Unit ax Imosed on Sellers => Suly Effected => at the oint of sale any seller must now be given exactly $ more than before => Suly curve shifts u by $ Effect of imosing a Per Unit ax: Imosing a Per Unit ax will Decrease the traded of the good Decrease otal Consumers Surlus Decrease otal Producers Surlus Increase the rice aid by consumers Decrease the rice received by sellers Create a ositive Deadweight Loss (since less than the efficient amount of trade will take lace) Comarison of Per Unit ax of $ imosed on Buyers to Per Unit ax of $ imosed on Sellers : he final imact of imosing a Per Unit ax of $ on buyers is identical in every asect to imosing a Per Unit ax of $ on sellers his follows from the recognition that under either olicy, the resulting level of trade is the unique level of trade at which buyer s reservation rice exceeds seller s reservation rice by exactly the magnitude of the tax Intuition: In a market with no tax, market forces induce buyers and sellers to trade all units for which there is a ositive gain. hat is, all units for which: r b r s or equivalently rb rs. When a er unit tax of $ is imosed in a market (on either buyer or seller), market forces will induce buyers and sellers to trade all units for which there will be a ositive gain from trade after the government takes its cut of $. hat is, all units for which: r r or equivalently rb rs (note: when a tax of $ is imosed on a buyer, the net benefit of obtaining an item valued at r b is only r b ) or equivalently rb rs (note: when a tax of $ is imosed on a seller, the net cost of relinquishing an item valued at r s becomes r s ). b s

3 When imosing a Per Unit ax, the two otential goals of generating tax revenue and discouraging consumtion of a good are often at odds with one another. Intuition: Recall that the government only gets the tax revenue of $ er unit on those units that are traded with the tax in lace. (i) If a tax effectively discourages consumtion, then eole are no longer buying a large of the good once the tax is in lace => very little revenue will be generated (ii) If a tax generates a whole lot of revenue, then eole must still be buying a large of the good even with the tax in lace => consumtion of the good must not have been discouraged by the tax

4 Outcome in the resence of a Price Ceiling : rice Suly a b c e f Excess at level of rice ceiling 2.35 d 4,8 6,75 9,7 free market outcome : 6,75 units traded, each at a rice of $3.7; CS=(a+b+e); PS=(c+d+f); DWL=(). Suose society decides this rice is too high and imoses a rice ceiling of c Consumers want to buy 9,7 units, but firms only wish to sell 4,8 => 4,8 units traded (less trade) rade takes lace at $2.35 (lower rice, for those who do get to urchase the item) PS=(d) => decrease in PS of (c+f) CS=(a+b+c) => change of (c-e) (total change in CS may be either ositive or negative; recall, consumers are the ones the olicy is intended to hel ) DWL=(e+f): ositive DWL, imlying an inefficiency Result: lower social welfare; all sellers clearly worse off; some buyers better off, but some buyers worse off (those who no longer get the item); total Consumers Surlus may be either smaller or larger than before

5 Outcome in the resence of a Price Floor : rice Suly a b c e f Excess Suly at level of rice floor 3.75 d 2,5 3,75 4,5 free market outcome : 3,75 units traded, each at a rice of $5.8; CS=(a+b+e); PS=(c+d+f); DWL=(). Suose society decides this rice is too low and imoses a rice floor of f 8.. Sellers want to suly 4,5 units, but buyers only demand 2,5 => 2,5 units traded (less trade) rade takes lace at $8. (higher rice, for those who do get to sell the item) CS=(a) => decrease in CS of (b+e) PS=(b+c+d) => change of (b-f) (total change in PS may be either ositive or negative; recall, sellers are the ones the olicy is intended to hel ) DWL=(e+f): ositive DWL, imlying an inefficiency Result: lower social welfare; all buyers clearly worse off; some sellers better off, but some sellers worse off (those who no longer sell the item); total Producers Surlus may be either smaller or larger than before

6 Note that the imact of a rice control on market articiants deends critically uon rice elasticities Examle: consider a rice floor imosed in a market to give sellers a higher rice (e.g., minimum wage) Case (i) relatively elastic demand : rice Suly ,75 4,5 Change in Producers Surlus is ( green area minus brown area ) => Change is clearly a Decrease in otal Producers Surlus hat is, the minimum wage increases the wage rate from $5.8 to $8. for only 75 workers, while causing 3, workers to no longer have jobs Policy does more harm than good for those it was intended to hel

7 Case (ii) relatively inelastic demand : rice Suly ,6 3,75 4,5 Change in Producers Surlus is ( green area minus brown area ) => Change is clearly an Increase in otal Producers Surlus hat is, the minimum wage increases the wage rate from $5.8 to $8. for 3,6 workers, while only causing 15 workers to no longer have jobs Perhas a good olicy (at least it seems to be heling the eole it is intended to hel )

8 Per unit tax of $ imosed on Buyers: B 2.9 $ Suly = (Seller s Res. Price) S a b c e d f = (Buyer s Res. Price) (Buyer s Res. Price)-() q 4,2 q 5, Outcome with tax in lace: Outcome at oint of sale determined by focusing on green curve and red curve 4,2 units traded <= unique at which buyer s reservation rice is exactly $=$1 above seller s reservation rice Price at the oint of sale is $1.9 Sellers receive $1.9 on each unit sold Buyers must ay $=$1 on to of the $1.9 urchase rice, for a total of $2.9 on each unit urchased CS decreases by (a)+(b)+(c) <= Incidence for buyers PS decreases by (d)+(e)+(f) <= Incidence for sellers Government tax revenue of (a)+(b)+(d)+(e) (equal to ($1)(4,2)=$4,2). Note, government tax revenue is less than $5,, since they only collect the $1 of tax on units which are traded when the tax is in lace. Less than efficient level of trade => DWL of (c)+(f)

9 Per unit tax of $ imosed on Sellers: B S $ a d e f b c (Seller s Res. Price)+() Suly = (Seller s Res. Price) = (Buyer s Res. Price) q 4,2 5, Outcome with tax in lace: Outcome at oint of sale determined by focusing on orange curve and blue curve 4,2 units traded <= unique at which buyer s reservation rice is exactly $=$1 greater than seller s reservation rice Same is traded with the tax imosed on sellers as when the tax was imosed on buyers => all other asects of the outcomes are identical! hat is: Sellers receive $1.9 while buyers ay $2.9 on each of the 4,2 units traded he decrease in CS, decrease in PS, amount of government tax revenue, and magnitude of DWL are all the same as when the tax was imosed on buyers instead of sellers It makes NO DIFFERENCE in terms of welfare (to buyers, sellers, or society) if this er unit tax is imosed on buyers or imosed on sellers! q

10 Who bears the burden of a tax? Consider the following two cases: (i) Elastic Suly with Inelastic B S $ Suly Big increase in rice for buyers, but small decrease in rice for sellers Big decrease in CS, but small decrease in PS (ii) B Inelastic Suly with Elastic $ Suly S Small increase in rice for buyers, but big decrease in rice for sellers Small decrease in CS, but big decrease in PS

11 Will a tax generate a lot of revenue and/or discourage trade? Consider the following two cases: (iii) Elastic Suly with Elastic $ Suly q q Big decrease in consumtion, but very little tax revenue generated (iv) Inelastic Suly with Inelastic $ Suly q q A great deal of tax revenue generated, but a very small decrease in consumtion

12 Problem: 1. Consider a market with demand given by the inverse demand function 1 ( q) 6 q and suly given by the inverse suly function P D 2 3 P S ( q) 1 2 q. 1A. How much trade would take lace in this market if a Per Unit ax of $5 were imosed on sellers in this market? Exlain. 1B. How much tax revenue would be generated by imosing a Per Unit ax of $1 on buyers in this market? Exlain. ultile Choice Questions: 1. A refers to a legal restriction on the rice at which trade can take lace. A. Deadweight Loss B. Per Unit ax C. Price Control D. ax Incidence 2. One could otentially argue in favor of imosing a Per Unit ax, based uon the recognition that such taxes generally A. generate tax revenue for the government. B. discourage the sale/consumtion of a good. C. increase otal Consumers Surlus, by increasing consumtion. D. ore than one of the above answers is correct. 3. In the United States, Price Controls were imosed on a wide range of goods in an unsuccessful attemt to combat inflation by A. President John Kennedy, after the Bay of Pigs Invasion. B. President Richard Nixon, in the early 197 s. C. President George Bush, shortly after the 9/11 errorist Attacks. D. President Donald rum, immediately after taking office. 4. If demand is very elastic and suly is very inelastic, then imosing a Per Unit ax will result in A. a big decrease in rice received by sellers, but only a small increase in rice aid by consumers. B. only a small decrease in rice received by sellers, but a big increase in rice aid by consumers. C. no change in the rice received by sellers or the rice aid by consumers. D. None of the above answers are correct. 5. Imosing a rice floor will generally A. make all sellers of the good better off. B. increase the traded of the good. C. make all buyers of the good worse off. D. ore than one of the above answers is correct.

13 For questions 6 through 9, consider a market with demand and suly as illustrated below: rice 2 Suly a b d f c e In comarison to the free market outcome, imosing a rice ceiling of $8. in this market would: A. increase otal Consumers Surlus by areas (d)+(e). B. decrease otal Producers Surlus by areas (d)+(e). C. increase otal Social Surlus by areas (d)+(e). D. ore than one of the above answers is correct. 7. If a er unit tax of $2 was imosed on buyers in this market, then units of the good would be traded. A. less than 32 B. exactly 32 C. more than 32 but fewer than 4 D. exactly 4 8. Consider the following two roosed Per Unit axes: ax (A): a $4 Per Unit ax imosed on buyers and ax (B): a $4 Per Unit ax imosed on sellers. ax (A) would generate tax revenue of while ax (B) would generate tax revenue of. A. exactly $1,6; exactly $1,6 B. more than $1,6; less than $1,6 C. less than $1,28; more than $1,28 D. exactly $1,28; exactly $1,28 9. Imosing a rice floor of $8. in this market would A. have no imact on the market outcome whatsoever. B. create a Deadweight Loss equal to areas (c)+(d). C. make all buyers worse off. D. make some sellers worse off and some sellers better off.

14 Answer to Problem: 1A. When a Per Unit ax of $ is imosed in a market, the resulting level of trade will be the unique level at which rb rs. Recognize that the inverse demand function secifies the height of the demand curve and therefore buyer s reservation rice. Likewise, the inverse suly function secifies the height of the suly curve and therefore seller s reservation rice. From here it follows that the level of trade with the tax in lace must satisfy PD ( q) PS ( q). Substituting the secified functional forms into this equation 3 yields: 6 1 q 1 q 2 2. From here, it follows that q must satisfy: q => 2 q 5. hus, with a Per Unit ax of $ imosed in this market, the resulting level of trade is: q 5 5. With 5 this imlies q 2, 25. 1B. From the answer to art (1A) above, it follows that with a Per Unit ax of 1 imosed on buyers, q 5(5 1) (5)(4) 2, units will be traded. hus, this tax would generate tax revenue of ( )( ) (1)(2,) 2,. Answers to ultile Choice Questions: 1. C 2. D 3. B 4. A 5. C 6. B 7. C 8. D 9. A q