Notesale: Turn your study into money

Document Preview

Extracts from the notes are below, to see the PDF you'll receive please use the links above

---

5
...
1 Indirect Tax

Most economies are mixed economies --> free market + government intervention

3 most direct methods of intervention into free markets
• Taxes
• Subsidies
• Price controls

Indirect taxes are those taxes placed on goods and services
...
g
...
g
...
g
...

• E
...
10 % ad valorem tax on: $200 good is $20
$500 good Is $50

In the graph, the distance between S and S+ tax grows as the price increases
...
e
...



The effect of taxes: stakeholder consequences

Taxing the sales of a good has consequences
...

• Taxes reduce output: Supply shifts left because of the increased costs
...

• Market size shrinks: reduced output means a reduced market size
...

• Producers suffer: Producers face extra costs, produce less and are less likely to make
profits
...



5
...

The tax burden (incidence) is shared by both consumer and producer to different
degrees
...



Tax incidence: PED similar to PES

Price does not increase by the full amount of the tax
...

• Consumers pay more and receive less output
...

• Producer surplus is reduced as well
...

• Consumers are more responsive to changes, the same tax has led to a proportionally
smaller increase in the price paid by consumers but the difference between Qe and
Qtax is proportionally much greater
...

• The price has increased by much more ( consumers are less responsive to price, thus
more tolerant of price increase)
• Consumers pay more of the tax and producers pay less
• Government receives more tax revenue (consumers continue to buy the good in
similar numbers)
• Market size decreases relatively little and therefore employment is less affected
• The amount of deadweight is smaller

Summary
• The more ELASTIC the demand relative to supply, the greater the burden paid by
PRODUCERS, the greater the deadweight loss, the smaller the government revenue
• The more inelastic the demand relative to supply, the greater the burden paid by
consumers, (probably) the smaller the deadweight loss, and the greater the
government revenue)

Government are very tempted to tax goods for which PED is relatively inelastic
...
3 Subsidies

Subsidy is a payment made by the government to a firm for the purpose of increasing the
production of a good
- Government may have different motivation
• To increase the consumption of some good by lowering the price
...
The industry
might be considered critical for economic security - for example, steel-or might
be one of political influence
• To address a balance of payments deficit by increasing export revenue
...


Subsidizing a product will cause the supply curve to shift right or downwards by the amount
of the subsidy
...
4 Price controls: maximum price controls

Outcome of competitive markets are not optimal for all the participants --> in some of these
situations the govt enacts price controls to get different results

Price Ceilings

Govt determines that there is great potential for high prices and make a goal of keeping
prices low
...
When the price ceiling prevents a price
from rising to a higher equilibrium, we call it a biding or effective price ceiling
...

• The artificially low price has caused more demand for the product
• Producers cut production in response to lower price
• There will be many left wanting the good who previous would have consumed it, as
well as new entrants who will not access the good
...

• Some rationing methods include government-created ration cards or vouchers
...
This means less overall utility to
consumers and producers, a decrease in overall market surplus
...

• Price ceiling eliminates this efficiency
...
Society is not producing enough of the goods with
the price ceiling in place
...

• There are many more consumers who would be willing to pay more than Pmax (some
even more than Pe)

Black market graph --> at Qs supply curve shoots upward

At Qs, the demand curve rises high above Pmax or Pe
• This suggests that some consumers have a strong incentive to pay more,
informally or on the black market, to acquire the good
• Thus, supply curve shoots directly up at Qs
• Shows that price could rise as high as that point on the demand curve
• Thus some price ceiling may actually drive the price higher than the original
equilibrium

Others:

• Consumers may win or lose
...
No goods or black
market for others
...

• The expectation of a shortage can shift the immediate demand curve outward
and make black market prices actually exceed those shown in fig 5
...
---> black market

•

Finally, owners have little incentive to maintain their buildings (revenue is
limited by the price ceiling so they seek to maintain profits by reducing costs) This can lead to unsafe and poor-quality housing for the occupants ---> poor
quality


Housing subsidy

In rare situations, governments may be persuaded to solve the housing shortage
caused by rent control by subsidizing the market for low income housing - likely to be
costly


5
...


Reduced market size
• Because only amount Qd will be purchased, the market size decrease
...


Cost inefficiency
• The higher price increases production fro Qe to Qs
...


Allocative inefficiency
• The higher price inspires producers to produce at a quantity of output at which
marginal cost is well above the marginal benefit, beyond where supply and demand
meet
...


Informal (black) markets
• Firms may choose to sell their price below equilibrium
...


Example of price floors
• Agricultural price supports

•
•
•
•

Price supports to raise farmer's income by providing a better market price
Increases price and decrease in quantity demanded
Consumer surplus decreases
Govt may have to purchase excess supply
• Has to arrange to sell it to another country but countries may protest
• Much of the output may be destroyed - clear waste of resources


•

•

Minimum wage
• Used as a tool to raise living standards among the poor
• Minimum pay for all workers, and those earning the least wages will be able to
get basic necessities
• If price of labour above equilibrium,
• Quantity of labour demanded by firms decreased
• Higher wage has brought new entrants into the labour market
• Unemployment occurs due to surplus
• Those still employed enjoy the higher wages at the cost of unemployment
for other workers
• Increased incentives for firms to hire illegal workers, typically migrants, for
their cheapest jobs

Fixed prices
• Firms may set a fixed price on their own
• Depending on the good, the price may be fixed below or above the equilibrium
• E
...
sporting events, movies, plays and concerts
• The amount of supplied by the seating capacity is fixed, so supply is completely
inelastic
• Demand, however, can vary significantly
• If set too high, there will be a surplus of tickets
• Extra seats will be sold on the black market to buyers willing to pay a price
in line with demand
• If set too low, there will be a shortage
• This shortage will also be sold at the black market - buyers between qe
and qd will bid the price higher by making online offers or buying the
ticket more expensively outside the event itself
• Theatres - make up for this by having variety of shows and having multi-screen
buildings
...

• Sporting venues - charge different prices for different seats, effectively
discriminating between those at different points (high and low) on the demand
curve
...
There is also comparatively less deadweight
loss as opposed to when PED > PES
...



Short term: consumers unresponsive to changes in price as they need time to adjust their
consumption
...
This would have caused
total demand to decrease
...
Rich
consumers would not change consumption by much as it makes relatively little proportion of
their income where as poor consumers would have to adjust their consumption
...


Pro: The most clear benefit of this taxation is the significant government revenue, which
could be used to improve the social welfare
...
Also, young or poor consumers who have lower incomes will no
longer be able to consume that good
...


Stakeholders:

Producers - Producers suffer as they face extra costs, producer less and have a lower chance
of making profit
...
Thus, they end up paying more to get less
...


Non - consumers -

Rich & poor

Old & young

Short term

Long term


Tax --> elastic goods





Price control

Price floor

Short term: In the short term, consumer's demand will be inelastic as it is difficult for them
to immediately find a substitute and reduce consumption
...


Pro:

Con:

Stakeholders:

Producers -

Consumers -

Government -

Non - consumers -

Rich & poor

Old & young

Short term

Long term

Conclusion



Price ceiling

Fixed price





---