The Effects of a Tax. Econ 410: Micro Theory. Recall from last time. The Effects of a Tax. Competitive Markets and Policy. Slide 3. Slide 1.

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1 lide 1 lide 3 The Effecs of a Tax Econ 410: Micro Theory ompeiive Markes and Policy Monday, November 19 h, 2007 u in his world nohing can be said o be cerain, excep deah and axes. -enjamin Franklin How will a compeiive firm respond o a ax on is oupu? n oupu ax paid by producers will increase a firm s marginal cos by he amoun of he ax. How will his affec oupu for he firm? The indusry? lide 2 lide 4 Recall from las ime The Effecs of a Tax We have seen how a firm reacs o changes in prices and coss in boh he long and shor run We can now apply his knowledge of compeiive markes o analyze a wide variey of governmen policies ($) P 1 n oupu ax raises he firm s marginal cos by he amoun of he ax. M 2 = M 1 + ax M 1 The firm will reduce oupu o he poin a which he marginal cos plus he ax equals he price. V 2 Taxes Floors and uppors V 1 eilings Tariffs and Quoas q 2 q 1 Oupu

2 lide 5 lide 7 The Effecs of a Tax urplus: Review ($) 2 = onsumer urplus P 2 P 1 Tax shifs 1 o 2 and oupu falls o. increases o P 2. Producer urplus Oupu lide 6 lide 8 Measuring Welfare In order o discuss a policy s poenial impacs, we need a measure of social welfare Where have we seen his before? One way o do his is by using producer and consumer surplus Recall: onsumer surplusis he oal benefi or value ha consumers receive beyond wha hey pay for a good Producer surplusis he oal benefi or revenue ha firms receive beyond wha a good coss o produce Wha do hese look like graphically? Measuring Welfare To deermine he welfare effec of a governmenal policy, we can measure he gain or loss in consumer and producer surplus Example binding price ceiling When price is held below he equilibrium level, he Q d >Q s shorage develops How does his policy affec consumer and producer surplus? ome consumers will win, some will lose. Producers in general will be worse off.

3 lide 9 lide 11 P max onrols onsumers ha can buy he good gain onsumers ha canno buy, lose The loss o producers is he sum of recangle and riangle Triangles and are losses o sociey dead weigh loss uppors Much of agriculural policy is based on a sysem of price suppors s se by governmen above free-marke level Mainained by governmenal purchases of excess supply The governmen can also increase prices by resricing producion Wha are he impacs o consumers, producers, and he federal budge? lide 10 lide 12 onrols The deadweigh lossin he graph illusraes he inefficiency caused by he price conrols Toal loss in surplus (consumer + producer) If demand is inelasic, losses o consumers may be large These same inefficiencies can be shown wih price floors P max uppors Who wins? Who loses? onsumers lose hey mus pay a higher price for he good omesic producers win-hey are selling more a a higher price Producers in oher counries lose Why? Taxpayers lose The cos of buying he surplus is funded by axes ociey is worse off overall Less cosly o simply give farmers he money How could we measure he oal welfare effec of his policy?

4 lide 13 lide 15 uppors P s To mainain a price P s he governmen buys quaniy Q g. Q g E To do his, he governmen mus spend Q g * P s omesic producers gain ++. onsumers lose +. Toal Loss o sociey = E +. + Q g Tariffs and Impor Quoas Many counries use impor quoas and ariffs o keep he domesic price of a produc above world levels Impor quoas: Limi on he quaniy of a good ha can be impored Tariff: Tax on an impored good This gives domesic producers higher profis, bu a he expense of consumers How could we illusrae he impacs of a quoa graphically? lide 14 lide 16 ompeiive Efficiency Policies ha cause dead weigh losses are said o impose an efficiency cos on he economy If efficiency is he goal, hen leaving markes alone could be he answer However, as we have already learned, marke failures can occur s fail o provide proper signals, leading o inefficiency Oher han in hese cases, unregulaed compeiive markes lead o economic efficiency 1 s Fundamenal Welfare Theorem P W Tariffs and Impor Quoas In a free marke, he domesic price equals he world price P W. Q Impors ince he free marke price causes domesic demand o exceed supply, goods are impored from abroad. Q quoa of resricing impors o pushes he domesic price o impors go o zero. Loss o consumers is ++. Gain o producers is. ead weigh loss: +.

5 lide 17 lide 19 Tariffs and Impor Quoas uppose he governmen imposes a ariff o se he marke price o P* The same ype of increase in domesic prices could also be achieved by a ariff Q increases, Q decreases omesic producers gain onsumers lose eadweigh Loss = + Governmen Revenue = ariff * impors P P* P w Q Q Q Q Q Tax = $1.00 uyers lose + P b price buyers pay P price producers ge ellers lose + The governmen gains + in ax revenue. The deadweigh loss from he ax is +. How would he elasiciies of demand and supply affec each area in he graph? lide 18 lide 20 udying ax incidenceells us which paries bear he burden of a ax Usually he burden of a ax will fall parly on he consumer and parly on he producer Who acually pays a ax will depend on he relaive elasiciies of demand and supply in a marke For simpliciy, le s consider a specific axon a good Tax of a paricular amoun per uni sold In he previous example, he ax burden was shared almos equally beween producers and consumers Relaive elasiciies affec ax burden If demandis relaively inelasic, however, burden of ax will fall mosly on buyers If supplyis relaively inelasic, he burden of ax will fall mosly on sellers eadweigh loss is minimized when boh curves are somewha inelasic. Why?

6 lide 21 emand Relaively Inelasic: urden on uyers upply Relaively Inelasic: urden on ellers P b P b P0 P P lide 22 For nex ime Please read secions 9.2, and of your exbook. Pracice Problem e The assigned problems will no be graded, bu may be submied for feedback oing hese problems will help you learn he maerial in preparaion for he final exam. Reminder Your (graded) problem se is due a he beginning of nex Monday s class