THE MARKET AND ALLOCATIVE EFFICIENCY (3.1) Government Intervention & Allocative Efficiency

Transcription

1 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) Government Intervention & Allocative Efficiency 61

2 62 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) BEFORE you start this unit (in pencil)... write the key idea of this unit in the centre of the page write what you know about this idea around it and draw lines to them. try and group the ideas together Mind-maps are very good revision tools. Our minds learn by making patterns. Mind-maps help you to make these patterns and so makes the content easier to learn and remember. mind-map AFTER you finish this unit (in pencil)... remove anything that doesn t belong to this unit ensure that things are grouped together appropriately. Move stuff around if needed add any extra ideas that you think are missing

3 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 6 unit overview I just want to be free... o far we ve looked at free or competitive markets, i.e. markets where market forces (supply and demand) are left alone to provide what consumers want and so achieve allocative efficiency. But for a variety of reasons the government may choose to intervene in a market. This unit looks at ways that governments intervene in markets, and how this reduces the allocative efficiency of markets and creates deadweight loss. by the end of this unit, you should be able to answer these questions... 1 how does the government intervene in international trade markets? 2 what s a sales tax and how does it affect allocative efficiency? government intervention & allocative efficiency what s a subsidy and how does it affect allocative efficiency? 4 how do fixed prices (price ceilings) affect allocative efficiency?

4 64 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) R.L.T. # 5... put your parents to work Hard to believe, but your parents can be a great learning tool. Explain what you are learning to them. Trying to explain something to someone else is one of the best ways to learn. Hopefully they ll ask questions which you ll have to try and answer. (hint... stop when they start snoring) LEARNING I ACTIVE... EXERCIE YOUR BRAIN... MAKE CONNECTION... YOUR MIN I NOT A BUCKET

5 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 65 topic.1 international trade - tariffs & quotas get more protection Countries trade with each other when domestic firms look to overseas markets to export their goods or services and so increase their profit, or consumers wish to import goods and services made overseas. This is a logical extension of competitive or free markets within an economy. However international trade is also affected by international politics as firms try to give their domestic firms a competitive advantage or protect a country s strategic interests. This topic looks at how a government can intervene in international markets through the use of tariffs and quotas... and how this impacts on allocative efficiency. by the end of this topic, you should be able to... o describe international trade o show market equilibrium in a two-country model o illustrate trade between New Zealand and the world o show changes to international trade o describe international protectionism o show the impact of tariffs on trade and allocative efficiency o show the impact of quotas on trade and allocative efficiency remember - try the exercises and then read the notes to learn what you don t know...

6 66 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 The graphs below show the market for soap in New Zealand and Australia (ignoring exchange rates). 1. On the graphs show the equilibrium price and quantity in both countries. 2. Calculate the after-trade equilibrium price (note: both graphs are in NZ$). how this on the graph.. how local production ( P ), local consumption( C ), imports (M) and exports (X) after trade. $ Graph 1: NEW ZEALAN MARKET FOR OAP $ Graph 2: AUTRALIAN MARKET FOR OAP 8 8 A Exercise.1 International Trade Complete the table below: NZ Before Trade Equilibrium price in New Zealand $ $ Equilibrium price in Australia $ $ After Trade omestic production in New Zealand bars bars Change in New Zealand domestic production omestic production in Australia bars bars Change in Australian domestic production NZ (000 s bars) omestic consumption in New Zealand bars bars bars bars A (000 s bars) Change in New Zealand domestic consumption Who is better off from trade in New Zealand? Who is better off from trade in Australia? bars consumers / producers consumers / producers 5. Based on you analysis above, should New Zealand trade with Australia? Why (not)? Yes No

7 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 67 The graph below shows the early days of the New Zealand wine industry, when New Zealand firms were struggling to establish themselves in New Zealand and internationally against overseas companies. NZ$ Graph : NEW ZEALAN MARKET FOR WINE 100 NZ The New Zealand government decides to impose a $10 tariff on imported wine. how this on Graph. Label the new world price (WP 2 ). 2. Identify the new quantity of imports, local production and local consumption.. how the loss of consumer surplus resulting from imposing the tariff. 4. Complete the table below: Before the Tariff After the Tariff omestic production litres omestic production litres Revenue earned by local firms $ Revenue earned by local firms $ uantity imported litres uantity imported litres Value of imports $ Value of imports $ omestic consumption litres omestic consumption litres WP NZ Revenue from tariff $ (millions of litres) Exercise.2 Imposing a Tariff 5. Now that the industry is more mature, why is there less of an argument for the government to protect local producers from imports?

8 68 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 Imagine game consoles can be imported direct to New Zealand for an average price of New Zealand $00 (including transport costs, etc.). NZ$ Graph 4: NEW ZEALAN FOR GAME CONOLE NZ Exercise. Imposing a Tariff On Graph 4, show the effects on the New Zealand market due to the world price (WP) for Game Consoles being lower than the equilibrium price in New Zealand. 2. Imagine the New Zealand government places a $100 tariff on all Game Consoles imported into New Zealand. how this on Graph 4 (WP+ Tariff) and answer the questions below.. Use coloured pencils to shade the following areas (after the tariff is imposed): The revenue of local producers. The revenue to firms importing Game Consoles. The total tariff paid to the government NZ 4. Calculate the following values (after the tariff is imposed): a. Number of locally made Game Consoles b. Total consumer spending $ c. Revenue to local firms $ d. Total tariff paid to government $ e. Value of imports $ f. Number of imported Game Consoles 5. On Graph 4, identify the deadweight loss (loss of allocative efficiency) resulting from the tariff being imposed.

9 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 69 Again, imagine the same market for Game Consoles that are imported directly to New Zealand for an average price of New Zealand $00 (including transport costs, etc.). NZ$ Graph 5: NEW ZEALAN FOR PLAYTATION NZ On Graph 5, show the effects on the New Zealand market due to the world price (WP) for Game Consoles being lower than the equilibrium price in New Zealand. 2. Imagine the New Zealand government places a quota of 750 Game Consoles per year that may be imported into New Zealand. how this on the graph above and answer the questions that follow.. Use coloured pencils to shade the following areas on Graph 5 (after the quota is imposed): NZ uantity of Playstations Exercise.4 Imposing a uota The revenue to local producers. The revenue to firms importing Game Consoles. 4. Calculate the following values (after the quota is imposed): a. Number of locally made Game Consoles b. Total consumer spending $ c. Revenue to local firms $ d. Value of imports $ e. Number of imported Game Consoles

10 70 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 how the world price of $15 on the graph below. Label this WORL. NZ$ Graph 6: NEW ZEALAN MARKET FOR POCKET KNIVE NZ Exercise.5 Imposing a uota how the quantity of goods supplied locally ( NZ ), the quantity of goods demanded ( NZ ) and imports.. The New Zealand government imposes a quota of pocket knives that can be imported into the country. how this and the resulting changes to imports on the graph. 4. how the the following areas on the graph after the government has imposed the tariff: the new consumer surplus the extra increase in producer surplus the government revenue from the tariff the deadweight loss Using the graph above as example, explain what deadweight loss is. 6. Complete the table below: Before Trade After Trade (Before uota) Total revenue for New Zealand producers $ $ $ NZ (000 s) After Trade (After uota) Total expenditure by New Zealand consumers $ $ $ Consumer urplus $ $ $ Producer urplus $ $ $ uantity upplied by Local Producers uantity emaned by Local Consumers

11 International Trade THE MARKET AN ALLOCATIVE EFFICIENCY (.1) notes 71 Trade is important to the economies of most countries in the world. It helps economies by increasing the size of the market available to domestic firms this is especially relevant to firms in small economies such as New Zealand. It is also necessary if a country wants to import goods from overseas. To do this they need foreign currency, which the country earns by selling goods and services abroad (i.e. exporting). how Market Equilibrium in a Two-Country Model Trade between two or more countries can occur when one country is able to produce more of a good or service than its own (domestic) consumers demand and it can produce the good or service more cheaply than producers in another country. We can use supply and demand analysis to show how and why producers and consumers in different countries trade with each other. To simplify the analysis, we will ignore exchange rates and the cost of freight (transport). Figure.1 shows two countries trading with each other. However it is not all good. In Albania, consumers bought teapots per annum ( A ) at $5 (P A ) each before trade. After trade consumers only buy 000 teapots each year ( 1 ) at a price of $7 (P W ). Teapot consumers in Albania are worse off. In Bolivia, domestic producers sold 000 (P B ) teapots annually for $9 (P B ) before trade. After trade they only sell ( ) teapots for $7 (P W ) each. Their annual revenue has fallen from $ to $ Figure.1... Two-Country Model of International Trade ALBANIAN MARKET FOR TEAPOT BOLIVIAN MARKET FOR TEAPOT U$ P W P A A A (000pa) U$ P B P W B B (000pa) 1 A 2 B 4 Before Trade In Albania, teapots sell for $5, while in Boliva they sell for $9. After Trade omestic ales Exports omestic Production Imports Realising that they can sell teapots for a higher price in Bolivia, Albanian firms will export to Bolivia. This will cause the price in Bolivia to fall as Albanian firms sell their teapots below the market price. At the same time, the price in Albania will rise. The opportunity cost of selling teapots in Albania (i.e. what firms can earn in Bolivia) rises due to trade. This will cause Albanian firms to raise the price of teapots in Albania to match the price they can earn in Bolivia. The prices will rise in Albania (to P W ) and fall in Bolivia (to P W ) until they are equal and the quantity exported equals the quantity imported. The graphs above show the quantity of exports ( 1 to 2 ) and imports ( to 4 ) at the new price (P W ).

12 72 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) Illustrate Trade Between New Zealand and the World The section on the previous page shows two countries who share a double coincidence of wants, i.e. they both want to trade with each other at the same time. In reality, most New Zealand firms sell to a number of geographic markets (e.g. Japan, UA) throughout the world. Figure.2 shows how we use supply and demand graphs to illustrate New Zealand importing a good from overseas. P NZ P W $ MARKET FOR COMPUTER NZ NZ NZ omestic Production NZ Imports NZ World upply (000pa) Figure.2... New Zealand as an Importer Before Trade The equilibrium price is $2 000 (P NZ ) and quantity is ( NZ ). After Trade Overseas firms sell to New Zealand consumers at a lower price (P W ) than P NZ. omestic consumers are better off because they are buying more computers at a lower price. omestic producers are worse off because they are selling less computers at a lower price and so their revenue has fallen from $ to $ after trade. Alternatively Figure. shows how we illustrate New Zealand exporting a good. $/MT 8 7 P W P NZ MARKET FOR TIMBER NZ NZ World emand (000 MT pa) Figure.... New Zealand as an Exporter Before Trade MT ( NZ ) of timber is sold to local customers for $4/MT (P NZ ). After Trade New Zealand producers can earn a higher price overseas than P NZ. Therefore, they will export timber overseas. This will result in the price in New Zealand rising (see Figure 9.5 for discussion of this) and local sales falling form NZ to NZ. omestic ales NZ NZ Exports NZ Figure.4... New Zealand Compared to the World Market The New Zealand market is microscopic compared to a total world market. We represent less than 0.2% of world trade. P W WORL $ W W W NZ $ You will notice that in both Figures. and.4, the world price is shown as a horizontal line, i.e. perfectly price elastic. When New Zealand is importing, the horizontal line represents world supply. New Zealand is too small to influence the price and so world supply is shown as purely elastic. Overseas suppliers can produce whatever New Zealand demands at the same marginal cost of production and therefore price. When New Zealand exports, the horizontal line represents world demand. With so many overseas consumers and producers, New Zealand firms are tyipically price takers because they are so small by world standards and cannot influence world demand. One exception to this is Fonterra which is a leading international trader of dairy products.

13 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 7 how Changes to International Trade Because New Zealand is so small compared to overseas economies and firms, New Zealand firms are often (but not always) price takers when it comes to international trade. Figure.5 below shows how New Zealand markets respond to a change in international trade. Figure.5... Changes to International Trade If the world supply falls then prices will rise globally. In New Zealand, the price will rise, resulting in more locally produced goods (0 to 2 ) and less imports ( 2 to ). $ NEW ZEALAN MARKET NZ $ P W 1 WORL MARKET 1 W W P 1 W 1 W 2 1 W P W W NZ 2 Imports 1 4 Imports how the Impact of Trade on Allocative Efficiency As we saw above, international trade can be good for consumers and producers. Consumers benefit from imports by being able to buy a wider range of goods and services at a cheaper price. Producers benefit from being able to sell their products overseas. These benefits can also be shown in terms of their impact on consumer and producer surplus, and therefore alloactive efficiency in a market. This is shown in Figures.6 and.7 below. $ MARKET FOR COMPUTER Figure.6... Imports and Allocative Efficiency Consumer urplus Producer urplus NZ NZ (000pa) Before Trade Both consumer and producer surplus are maximised. $ MARKET FOR COMPUTER Consumer urplus Producer urplus NZ NZ Imports World upply (000pa) After Trade World supply is below the NZ market price, resulting in imports and a lower prices in the market. Consequently consumer surplus (the area between price paid and the demand curve) has grown. However producer surplus for domestic producers has reduced as they now sell less at a lower price.. This market is still allocatively efficient, as consumer and producer surplus are both maximised.

14 74 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) $ Consumer urplus Producer urplus MARKET FOR MILK NZ NZ (m litres) Figure.7... Exports and Allocative Efficiency Before Trade Both consumer and producer surplus are maximised. $ Consumer urplus Producer urplus MARKET FOR MILK NZ NZ Exports World emand (m litres) After Trade Overseas demand leads to New Zealand firms exporting. This causes the price in the price of goods in New Zealand to rise as local producers can export at a higher price. This increases the producer surplus, but reduces the consumer surplus. This market is still allocatively efficient, as consumer and producer surplus are both maximised. escribe International Protectionism The general trend in international trade is towards lowering government intervention, i.e. increasing the opportunities for free trade. Multi-lateral organisations such as the World Trade Organisation (WTO) and trade agreements such as Closer Economic Relations (CER), exist to promote greater trade between countries. However, a great deal of international protectionism exists. International protectionism is when a government intervenes in international markets to reduce or hinder the overseas competition faced by local firms. Governments do this for a various reasons: New Industries New industries often have high start-up costs. A government may protect them long enough to establish themselves and then be able to compete internationally. Local Jobs Overseas competition may cause local firms to close down and lay off staff. Protecting local firms from overseas competition can preserve local jobs. trategic Industries A particular industry may be one that a country does not want to rely on other countries for, e.g. energy production, food, military hardware. Unfair Trade Practices Overseas governments sometimes unfairly support their firms through subsidies or other means. Or large foreign firms may dump their goods at ridiculously low prices to force domestic firms out of business (and then they raise the price). The government may try to protect local firms from such unfair trade practices. The two types of international protectionism we will look at are tariffs and quotas.

15 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 75 how the Impact of Tariffs on Trade & Allocative Efficiency A tariff is a tax on imported goods or services. It protects domestic firms from overseas competition by raising the price of imported products to local consumers. This means that local firms can sell more at a higher price good for them but bad for consumers. Figure.8 shows the impact of a tariff on international trade. The are several points to note about the changes shown: Identify the Tariff The tariff is shown by raising the world supply curve the amount of the tariffs. In Figure.8 the supply curve is raised by $20. Imports are Reduced The volume of imports (the horizontal distance between NZ and NZ ) falls as the price rises and local firms increase their quantity supplied. Identify the Government Tax Revenue A tariff is a tax and so is paid to the government. The total revenue from the tariff is shown by the rectangle shown as the volume of imports multiplied by the value of the tariff. eadweight Loss This is shown by the black triangles. Read the notes below Figure.8 to explain what deadweight loss is. P 1 W P W $ MARKET FOR TEAPOT NZ NZ W + TARIFF $20 Tariff W (000 pa) Figure.8... how a Tariff A tariff is shown as a vertical increase in the world supply curve. This pushes the market price up to $60 per teapot ($40 + $20 tariff). As a result, imports fall from ( ) NZ NZ to ( 1 NZ 1 ). Importer s Revenue falls NZ from $ to $ At the same time local production rises from ( ) to NZ (1 ), and local firms NZ revenue grows from $ to $ Government revenue from the tariff (shaded area) is $40 000, i.e. the tariff ($20) multiplied by the new quantity of imports (2 000). NZ 1 NZ 1 NZ Imports After Tariff Imports Before Tariff NZ Tariff Revenue eadweight Loss The tariff has helped protect local firms by increasing the market price. This is good for them as they now sell more goods at a higher price. However it is bad for local consumers as they buy less at a higher price. This idea can also be illustrated by looking at the impact of the tariff on the producers surplus and consumers surplus for local firms and consumers. Though it doesn t specifically show it, if you identify the consumer surplus before and after the tariff, you will see that it has decreased. omestic consumers are worse off. If you identify the producer surplus for local producers before and after the tariff, you will see that it has increased. Local firms are better off. The reduction in consumer surplus is not all transferred to producers. ome also goes to the government as revenue from the tariff. However some of the lost consumer surplus goes to neither firms or the government. Where does it go? Nowhere. This surplus is lost from the market. This lost surplus is called deadweight loss. eadweight Loss: The consumer or producer surplus lost due to intervention in a market and not gained by anyone else in exchange.

16 76 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) how the Impact of uotas on Trade & Allocative Efficiency A quota protects local firms by limiting the number of goods or service overseas firms can bring into a country. By restricting supply, the local market prices and local firms supply more. Figure.9 illustrates the impact of a subsidy on trade. The world can supply teapots more cheaply and so lowers the market price to $40. However because there is a quota, importers can no longer bring in enough teapots to satisfy quantity demanded. Because there is a shortage, consumers will bid up the price. As per the law of supply, firms will respond by increasing quantity supplied until supply equals demand at the new market price of $60 and quantity of teapots. A big difference between a tariff and a quota, is that quota s do not earn the government revenue. The increased price goes directly to overseas firms (or importers) who have an import licence under the quota scheme Like a tariff, a quota also creates deadweight loss. This is shown in Figure.9 as the black triangles Remember that, in this case, they show the consumer surplus that local consumers used to enjoy that is no longer a surplus for anyone in the market - consumers, producers or the government. P 1 W P W $ MARKET FOR TEAPOT omestic Production 2 Imports omestic Production NZ NZ + UOTA NZ W (000 pa) Figure.9... how a uota This graph shows the government imposing a quota of teapots. At the original world price of $40, local firms will produce teapots. Overseas firms then bring in more under the quota. At that level of output ( 2 ) and price (P W ), a shortage exists. Consumers will start to bid up the price. Because no more imports are allowed, local firms begin to supply again (as per the law of supply). until quantity supplied equals quantity demanded. at the new market price of $60. Revenue to Importers eadweight Loss R.L.T. # 6...isereviserevisereviserevisionrevi... Have you made a mindmap of what you ve learned yet? The trick to mindmaps is not to create one perfect summary of what you ve learned... because learning is active. The best mindmaps are quickly drawn and then thrown away. Focus on identifying the key (big) ideas and how they connect to each other. Learning the structure of what you are studying will help you to remember (and understand) it. LEARNING I ACTIVE... EXERCIE YOUR BRAIN... MAKE CONNECTION... YOUR MIN I NOT A BUCKET

17 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) topic.2 sales tax... plus a bit extra Governments use sales taxes to generate tax revenue or to discourage the consumption of certain products such as tobacco. This topic looks at what a sales tax is, how it works in a market, and how it affects allocative efficiency in a market. by the end of this topic, you should be able to... o describe a sales tax o show a sales tax o show the effect of a sales tax on allocative efficiency o show and compare the incidence of a sales tax on producers and consumers remember - try the exercises and then read the notes to learn what you don t know...

18 78 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 how the impact of a sales tax on the following graphs. 1. how the impact of a sales tax of $20 per bottle on the market for perfume. Price ($/bottle) MARKET FOR PERFUME P 1 40 Exercise.8 Imposing a ales Tax uantity (000 bottles) 2. a) how the consumer and producer surplus at market equilibrium in the market for petrol. Price ($/litre) P MARKET FOR PETROL uantity (million litres) 1 b) Calculate the value of... consumer surplus $ producer surplus $ c) On the graph show the following: the impact on the market of imposing a sales tax of $2 per litre on petrol. deadweight loss resulting from the sales tax revenue to the government from the sales tax consumer surplus after the sales tax producer surplus after the sales tax

19 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 79 The market for wine is shown in the graph to the right. 1. how equilibrium price and quantity on the graph. Price ($/litre) MARKET FOR WINE 2. Imagine the government imposes a sales tax of $0 on wine. how this on the graph.. After the sales tax, how much do consumers pay for wine, and how much revenue do producers earn? expenditure: $ revenue: $ 4. Who bears the main brunt of the sales tax consumers or producers? 5. Explain why the market price of wine did NOT rise by $0, i.e. the same amount as the (per litre) sales tax. 6. On the graph above, highlight the following areas (following the sales tax): consumer surplus producer surplus sales tax revenue deadweight loss 7. Explain the concept of deadweight loss. What is it? Why has it occurred? (000 litres) Exercise.8 Imposing a ales Tax 8. Indicate the following areas by stating the letters given on the graph alongside. a. Consumers surplus before tax. $ b. Total expenditure after tax. a c. Total revenue after tax. d. Total tax revenue. e. Incidence of sales tax on producers. f. Producers surplus after tax. b c d i h k g n m 9. What letter represents the point of allocative efficiency before the sales tax? e f 0 p q

20 80 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 Imagine two markets... porcupines (they make great pets!) and African tangerines (not such good pets). 1. On the graphs below, identify market equilibrium, producers surplus and consumers surplus. MARKET FOR PORCUPINE MARKET FOR AFRICAN TANGERINE Price ($) Price ($) Exercise.10 Imposing a ales Tax how the impact of a sales tax on each of the graphs below. Identify the new producer and consumer surplus and the deadweight loss. Price ($) MARKET FOR PORCUPINE Price ($) MARKET FOR AFRICAN TANGERINE ales tax of $ ales tax of $60. how the incidence of the sales tax on producers and consumers in both markets. 4. With reference to the two markets, describe how the sensitivity of consumers to changes in price (i.e. price elasticity of demand) affects the impact of a sales tax on the quantity of goods sold.

21 THE MARKET AN ALLOCATIVE EFFICIENCY ales Tax (.1) 81 notes escribe a ales Tax From time to time, governments impose a sales tax on a good or service. This may be done to generate tax revenue or to dissuade people from consuming a product. ales taxes are referred to as indirect taxes as consumers pay for the tax... but pay it to producers who collect it and then pay it to the government. The most common example of a sales tax in New Zealand is the Goods and ervices Tax, i.e. GT. However there are many other indirect taxes in New Zealand. youtube Figure Indirect Tax Consumers Producers Government Indirect taxes are paid by consumers but indirectly through producers who collect them on behalf of the government and then pay them to the government. ales Tax: A tax that is added to the price of a good or service, and paid when the good or service is sold. how the Effect of a ales Tax A sales tax is a cost to producers and so affects the supply curve. A sales tax increases firms costs of production and therefore decreases supply, i.e. supply moves upwards by the amount of the sales tax. Though the supply curve shifts up by the amount of the sales tax, typically the price will increase by a smaller amount. As the price rises for consumers they will consume less, i.e. falls. At the same time, producers are earning less per good, resulting in them choosing to produce less, i.e. falls. This idea is illustrated in Figure.11 where a sales tax of $1.50 per good only raises the market price by $1.00. This means that producers have chosen to absorb some (50c) of the sales tax in their selling price, and so they earn less revenue. The rest of the sales tax ($1.00) has been passed on to consumers through a higher market price. Figure Imposition of ales Tax $ 8 Imagine the government imposes a sales tax of $1.50 per unit. 7 6 TAX This increases firms cost of production, and the supply curve shifts up by the amount of the tax. This causes the market price to rise, though not by the full amount of the sales tax. Producers will absorb some of the sales tax into the price. 5 P2 4 P1 P 2 1 $1.50 ales Tax As price rises, the market quantity falls from 1 to 2. At this quantity consumers pay P1 ($4), but firms only receive P ($2.50). The difference goes to the government as tax revenue.

22 82 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) how the Impact of a ales Tax on Allocative Efficiency As a result of the sales tax, there will be a loss of allocative efficiency. Both consumers and producers surplus will decrease. ome of this surplus will go to the government as tax revenue, while some will be lost altogether i.e. deadweight loss. $ Figure ales Taxes and eadweight Loss 8 7 The imposition of the sales tax will reduce producer and consumer surpluses. P ome of this lost surplus will go to the government as tax revenue. The rest will be lost to the system and is called deadweight loss. P 1 P Consumer urplus - after the sales tax 2 eadweight Loss 1 Producer urplus ales Tax Revenue In Figure.12, the imposition of a sales tax ($1.50 per good) has caused the supply curve to shift upwards ( 2 ). As are result, consumers lose some of their surplus because they are now buying less goods ( 2 ) for a higher price (P 2 ). Producers lose some of their surplus as they are selling less goods ( 2 ) for a lower price (P ). ome of this lost consumer and producer surplus goes to the government as sales tax revenue (0 x $1.50 = $45... in the graph above). But some is lost entirely from the system, i.e. consumers and producers lose it and no one else gets it, not even the government. This is shown in Figure.12. Its value, if you calculate it, is $7.50 (½ x $1.50 x 10). how and Compare the Incidence of a ales Tax on Producers and Consumers (see tips 4 teachers re. elasticity... page 106) A government uses a sales tax for two main reasons - to raise tax revenue and modify the behaviour of producers and consumers. GT is a good example of a sales tax that is used to raise tax revenue. It applies to most goods and services and is the same rate (15%) for all of them. The government then uses this revenue to fund other government activities such as education, health, etc. Other sales taxes such as the excise duty on cigarettes are imposed to modify the behaviour of consumers and producers, i.e. get them to consume / produce less of the good. To see how much a sales tax will affect consumers and producers we need to examine the graph more carefully and look at who pays most of the sales tax. Producers could, in theory, absorb the entire sales tax into their existing sales price. This would reduce their profit but they wouldn t lose any customers. Alternatively a firm could choose to pass the entire sales tax on to customers by raising the selling price by the full amount of the sales tax. In practice firms usually do something in between, they pass on as much of the sales tax as possible to consumers by raising the price, but also pay some of the sales tax out of their own profits. The proportion of the sales tax paid by consumers and producers is call the incidence on consumers or producers. This is shown graphically in Figure.1.

23 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 8 P 2 P 1 P $ Figure.1... Incidence of a ales Tax on Consumers and Producers 2 1 To show the incidence of the sales tax on consumers and producers, start with the rectangle showing the whole sales tax. Then divide the rectangle by the original price. The area above the original price is the incidence of the sales tax on consumers. The area below the original price is the incidence of the tax on producers. In this graph, the sales tax of $ per unit has resulted in a price increase of $2 per unit. Firms have chosen to only pass on $2 of the sales tax to consumers. Firms will pay the other $1 of sales tax out of their profits. In this market, the incidence of the sales tax is greater on consumers. Incidence of the ales Tax on Consumers Incidence of the ales Tax on Producers How much of a sales tax that firms decide to pass on to consumers depends on the price elasticity of demand and supply. We will study price elasticity more in another standard. For now all you need to know is that price elasticity refers to how sensitive consumers and producers are to a change in price, e.g. how much will quantity demanded change in response to a change in price? If consumers are very price elastic, i.e. they are very sensitive to a change in price and likely to stop buying or buy less goods due to an increase in price, then firms will absorb most of the sales tax into the existing selling price. This situation is shown in Figure.14, where you will see that the incidence of the sales tax is greater on producers. $ Figure ales Tax in a Market with High Price Elasticity of emand 2 1 The consumers in this market are very sensitive to changes in the price, i.e. demand is price elastic. This means that a large number (not all) customers will stop buying the good if the price rises. P 2 P Unwilling to lose too many customers, firms in this market will absorb most of the sales tax into their profits rather than pass it on to customers through a higher selling price. P The result is that, as shown in the graph, the incidence of the sales tax falls mainly on producers. Incidence of the ales Tax on Consumers Incidence of the ales Tax on Producers 2 1 In figure.14, the sales tax has been effective from the government s perspective because it has caused consumers to demand less goods and firms to produce less goods ( 2 )

24 84 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) The alternative is a market where the demand for a good is price inelastic, i.e. consumers are less likely to change how much of a good or service they buy when the price changes. The market for cigarettes is a good example of this. Because of the nicotine in cigarettes, smokers are largely addicted to smoking them. Therefore an increase in price is unlikely to cause many smokers to stop buying cigarettes. This situation is shown in figure.15 below. Figure ales Tax in a Market with Low Price Elasticity of emand $ MARKET FOR CIGARETTE 2 The consumers in the market for cigarettes are not very sensitive to changes in the price, i.e. demand is price inelastic. Only a few customers will stop buying the good if the price rises. P In this situation, firms will pass on most of the sales tax to consumers through a higher selling price, because they know that they won t lose many customers by doing so. The result is that, as shown in the graph, the incidence of the sales tax falls mainly on consumers. P 1 P Incidence of the ales Tax on Consumers Incidence of the ales Tax on Producers 2 1 In a market such as the one for cigarettes, the government must impose a large sales tax on the good to signficantly change the behaviour of consumers and producers. Note: The analysis above has only discussed the price elasticity of demand. In fact we also need to consider the price elasticity of supply when analysing the incidence of a sales tax on consumers and producers. The final impact of a sales tax on the selling price... and therefore the behaviour of consumers (quantity demanded) and producers (quantity supplied) depends on the relative price elasticities of both demand and supply. R.L.T. # 7... i have a friend! Learning is a social activity. on t do it alone. Create or join a FACEBOOK group where you can share questions... answers... current economic events... etc. LEARNING I ACTIVE... EXERCIE YOUR BRAIN... MAKE CONNECTION... YOUR MIN I NOT A BUCKET

25 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) topic. subsidy... less a little bit Governments sometimes intervene in markets to encourage the production, and therefore consumption of goods. To increase output, the government must subsidise firms. This topic looks at what a subsidy is, how it works in a market, and how it affects allocative efficiency in a market. by the end of this topic, you should be able to... o describe a subsidy o show a subsidy o show the effect of a subsidy on allocative efficiency o show and compare the incidence of a subsidy on producers and consumers remember - try the exercises and then read the notes to learn what you don t know...

26 86 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 how the impact of a subsidy on the following graphs. 1. how the impact of a subsidy of $5 per bottle on the market for computer games. Price ($/bottle) 40 5 MARKET FOR COMPUTER GAME P 1 15 Exercise.11 Imposing a ubsidy 2. a) how the consumer and producer surplus at market equilibrium in the market for biofuel. b) how the impact of a subsidy of $2 per litre on biofuel on the market. Price ($/litre) P MARKET FOR BIOFUEL uantity (000 bottles) uantity (million litres) c) how the following: deadweight loss cost of the subsidy to the government consumer surplus after the subsidy producer surplus after the subsidy c) Calculate the following: cost of the subsidy to the government $ revenue earned by firms BEFORE the subsidy $ revenue earned by firms AFTER the subsidy $

27 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 87 ome people think that Teddy bears improve social cohesion. Imagine the Australian Government decides to subsidise the production of teddy bears. The graph to the right shows the market for teddy bears in Australia, including the subsidy. Price ($) 8 5 UBIY 1. Use two coloured pencils to shade in the new producers surplus and consumers surplus hade in the deadweight loss Use the figures from the graph to complete the following table: Before ubsidy After ubsidy Total Revenue Total Expenditure Producers urplus Consumers urplus 4. How has the subsidy affected producer and consumer surplus? producer surplus: consumer surplus: 5. How much is the per unit subsidy on teddy bears? $ 6. How much has the price of teddy bears fallen after the introduction of the subsidy? $ 7. Why has the price of teddy bears not fallen by the full (per unit) amount of the subsidy? Exercise.12 Imposing a ubsidy 8. What is the total cost of the subsidy to the government? $ 9. Calculate the incidence of the subsidy on consumers and producers. incidence of subsidy on producers incidence of subsidy on consumers $ $ 10. Explain why the incidence of the subsidy on consumers is different to the incidence on producers.

28 88 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 The markets for broccoli is shown below. Price MARKET FOR BROCCOLI P 1 Exercise.1 Imposing a ubsidy 1. Imagine that the government decides to increases consumption of broccoli by subsidising its production. how the impact of a government subsidy on the market for broccoli. 2. On your graph, identify the following: new market price (P UBIY ) new quantity sold ( UBIY ) the incidence of the subsidy on consumers the incidence of the subsidy on producers the deadweight loss resulting from the subsidy. escribe how producers and consumers are affected differently by the subsidy: 1 uantity 4. Explain why the impact of the subsidy on consumers is different to the impact on producers. 5. Explain why governments use subsidies in some markets... AN... why governments must consider the price elasticity of demand when considering the use of a subsidy.

29 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 89 ubsidy notes escribe a ubsidy A subsidy is the opposite of a sales tax. The government pays a subsidy to a firm to lower its costs of production and so encourage it to produce more. A subsidy raises the price that firms earn, causing them to produce more of the good or service - i.e. quantity supplied rises. At the same time the subsidy lowers the price paid by consumers, encouraging them to buy more, i.e. quantity demanded rises. how a ubsidy Because a subsidy lowers the costs of production to producers, the supply curve shifts down to the right. Figure.16 shows the impact of a subsidy of $1.50 per unit being imposed. The subsidy is shown by shifting the supply curve down by $1.50 at each quantity ( UBIY ). In Figure.14 the subsidy of $1.50 per good results in market price falling by $1.00 from P 1 to P 2. As the price falls, the market quantity rises from 1 to 2. The market price does not change by the full per unit amount of the subsidy. This is due to the interaction of supply and demand. At 2 consumers now pay $.00 per good and firms earn $4.50. The difference between the price consumers pay and the revenue firms earn is the per unit subsidy. The total cost of the subsidy to the government is shown by the grey box in Figure.16. In this case the subsidy costs $60, i.e. $1.50 x 40 goods. $ 8 Figure howing a ubsidy 7 The subsidy causes supply to shift downwards, causing price paid by consumers to fall from P 1 to P 2. P P UBIY UBIY uantity emanded will rise as consumers will now buy more goods ( 2 ) at a lower price (P 1 ). uantity supplied will also rise, as firms now earn more (P ) and so supply more ( 2 ). P 2 2 Note: The subsidy per good is $1.50. This is shown as the vertical distance between the two supply curves. The total cost of the subsidy to the government is $60. This is shown as the grey box shown on the graph. how the Effect of a ubsidy on Allocative Efficiency howing the effect of a subsidy on allocative efficiency can be a bit confusing. Have a look at Figure.17 over the page. This shows the producer and consumer surplus AFTER a subsidy. Before the subsidy, the consumer surplus would be the triangle below the demand curve down to the market price of $4.00. But now consumers pay a lower price, so the consumer surplus has increased down to the price of $.00. Producer surplus was the triangle above the supply curve and up to the market price of $4.00. Because firms now earn $4.50 per good, the producer surplus has grown to be the triangle from the supply curve up to the price firms earn, i.e. $4.50.

30 90 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) $ Figure ubsidies and eadweight Loss P P UBIY A subsidy increases both producers and consumers surplus. This is hard to show these graphically as the new surpluses overlap. eadweight loss is the black triangle between the two supply curves. This is the part of the full cost of the subsidy that doesn t go to either producers or consumers as a surplus. P Consumer urplus Producer urplus eadweight Loss 1 2 o with a subsidy, producer and consumer surplus overlap. How can this happen? How can both firms and consumers get the same surplus? It can happen because the government pays for the extra surplus with the subsidy. But the problem is the cost of the subsidy to the government exceeds the increased producer and consumer surplus. Go back to Figure.16 and identify the area on the graph that represents the full cost of the subsidy. Now show this on the graph in Figure.17. The part of the full cost of the subsidy that doesn t go to either producers or consumers as a surplus is the deadweight loss that results from a subsidy. This is show by the black triangle in Figure.17. how and Compare the Incidence of a ubsidy on Producers & Consumers In the case of a subsidy, the incidence on consumers and producers refers to the benefit each gets from a subsidy. For consumers, a subsidy increases the benefit they get over and above the price. For producers, the subsidy increases their profit. The incidence of a subsidy on consumers and producers surpluses can be shown on a graph in the same way as we do for a sales tax... except that it is done in reverse. The area of the rectangle representing the subsidy, that is above the original price, is the incidence of the subsidy on producers. While the area below the original price is the incidence of the subsidy on consumers. This is shown graphically in Figure.18. $ Figure Incidence of a ubsidy on Consumers and Producers The incidence of a subsidy on consumers is the area of the subsidy below the original price. The incidence of a subsidy on producers is the area of the subsidy above the original price. P P 1 4 UBIY Incidence of the ubsidy on Producers P 2 Incidence of the ubsidy on Consumers

31 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 91 The effectiveness of a subsidy is also affected by the price elasticity of demand and supply. Figures.19 and.20 show how a subsidy will be more effective in increasing quantity demanded and supplied in a market with low price elasticity of demand. P P 1 P 2 $ Figure ubsidy in a Market with Low Price Elasticity of emand UBIY The consumers in this market are very sensitive to changes in the price, i.e. demand is price elastic. This means that a large number of new customers buy the good if the price falls. Because they only need to raise the price by a small amount to increase sales, firms will keep most of the subsidy and only lower the price slightly. The result is that, as shown in the graph, the incidence of the sales tax falls mainly on producers. Incidence of the ubsidy on Producers Incidence of the ubsidy on Consumers 1 2 P P 1 P 2 $ Figure ubsidy in a Market with High Price Elasticity of emand UBIY The consumers in this market are not very sensitive to changes in the price, i.e. demand is price inelastic. This means that very few new customers buy the good if the price falls. Firms will need to pass on most of the subsidy to consumers by lowering the price to get a significant increase in the number of consumers buying this good. The result is that, as shown in the graph, the incidence of the sales tax falls mainly on consumers Incidence of the ubsidy on Producers Incidence of the ubsidy on Consumers Again... remember that in practice we need to consider the relative price elasticity of demand and price elasticity of supply to determine the full effect of a subsidy. R.L.T. # 8 Learning is finding the asnwers to what you don t know.... be question smart The intelligent place to find answers is by asking other people - your teacher, other students, parents, etc. Make sure you ask MART questions. ON T ask I don t get this. Tell me the answer. That s a bucket question. O ask I understand this part... can you please explain how this relates to what I already know? LEARNING I ACTIVE... EXERCIE YOUR BRAIN... MAKE CONNECTION... YOUR MIN I NOT A BUCKET

32 92 THE MARKET AN ALLOCATIVE EFFICIENCY (.1)

33 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 9 9 topic.4 fixed prices we shall not be moved The government sometimes imposes f ixed prices on markets to help consumers or producers. This topic looks at how maximum and minimum prices work, and how the impact on allocative efficiency. by the end of this topic, you should be able to... o describe fixed prices o show a maximum price o show the effect of a maximum price on allocative efficiency o show a minimum price o show the effect of a minimum price on allocative efficiency remember - try the exercises and then read the notes to learn what you don t know...

34 94 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 Famous examples of a maximum price include the markets for rental accommodation in New York and Helsinki. Exercise.1 Fixed Prices & Allocative Efficiency According to professors Niko Määttänen and Ari Hyytinen, price ceilings on Helsinki City Hitas apartments are economically highly inefficient. They cause queuing, and discriminate against the handicapped, single parents, elderly, and others not able to queue for days. They cause inefficient allocation, as apartments are not bought by those willing to pay the most for them. And those who get an apartment are unwilling to leave it, even when their family or work situation changes, since they can t sell it at what they feel the market price should be. These inefficiencies increase apartment shortage and raise the market price of other apartments. 1. how the current market price (P 1 ) and quantity ( 1 ) for the Hitas appartments on the graph below. Rent ( /week) how a impact of the Helsinki City Council imposing a price ceiling of 40 in the market.. Following the imposition of the price ceiling, identify the following in the market: quantity demanded quantity supplied consumer surplus producer surplus deadweight loss (accessed on 25/8/12) MARKET FOR HELINKI CITY HITA APPARTMENT Explain why the maximum price resulted in discrimination against people such as the handicapped and elderly. 5. Explain how the maximum price for Hitas Appartments might affect the market for other appartments in Helsinki.

35 Fixed Prices THE MARKET AN ALLOCATIVE EFFICIENCY (.1) notes 95 escribe a Fixed Price Governments may intervene in a market by fixing the market price. This might be done by setting a minimum price (price floor) or maximum price (price ceiling). how a Maximum Price To help consumers from excessive prices (usually for important or essential goods such as housing) governments may limit the market price of a good or service. This is known as a maximum price or price ceiling. Figure.21 shows the government imposing a maximum price of $150 on the market for rental properties. The problem is that while the intervention succeeds in lowering the price (P 1 to P 2 ), firms will respond by reducing the amount of rental housing they provide. This follows the law of supply which states that when price falls, so to will quantity supplied. Rent ($/week) P 1 P Market for Rental Housing MAXIMUM PRICE Figure howing a Maximum Price The maximum price (or price ceiling) causes the market price to fall from P 1 to P 2. This will cause quantity demand to rise to as per the law of demand and more consumers demand rental housing at the lower price. However quantity supplied will fall to 2 as firms are not willing to supply as much rental housing. The net effect is that less rental housing is provided in the market - albeit at a lower price for those lucky enough to get some how the Effect of a Maximum Price on Allocative Efficiency A maximum price will create a shortage, which the market is unable to fix due to the government restricting price signals. Figure.22 shows the impact of this on the allocative efficiency in the market. Ideally consumer would increase by expanding down to the new maximum price. However the choice of firms not to supply more than 2 means that there is deadweight loss as shown by the black triangle. The part of the full cost of the subsidy that doesn t go to either producers or consumers as a surplus is the deadweight loss that results from a subsidy. This is shown by the black triangle in Figure.22. Rent ($/week) P 1 P Market for Rental Housing Figure Maximum Prices & Allocative Efficiency MAXIMUM PRICE Ideally the maximum price should increase consumer surplus down to the new market price of $150 and out to the quantity demanded of 40. However firms choice to only supply 2 stops this happening. The black triangle shows the producer and consumer surplus that used to exist in the market and is now lost due to the intervention, i.e. deadweight loss. 50 Consumer urplus Producer urplus eadweight Loss

36 96 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) how a Minimum Price A government may decide to support producers by guaranteeing a minimum price for their goods. The New Zealand government used to guarantee dairy farmers a minimum price for milk. If the market price fell below the minimum price, the government would pay the difference between the price paid by consumers and the minimum price - i.e. a subsidy. Figure.2 shows the government imposing a minimum price of $5 per litre of milk. Firms will respond by increasing quantity supplied to 2. However the law of demand means consumers will demand less ( ). Rent ($/litre) Market for Milk Figure.2... howing a Minimum Price P 2 P MINIMUM PRICE The minimum price (or price floor) causes the market price to rise from P 1 to P 2. This will cause a surplus in the market as quantity supplied rises ( 2 ) and quantity demanded falls ( ) how the Effect of a Minimum Price on Allocative Efficiency A minimum price will create a surplus in the market. In Figure.2 this is the horizontal distance between 2 (quantity supplied) and (quantity demanded). Because the price signal is not able to work in this market due to the minimum price, the government must intervene further in the market to remove the surplus. Therefore the government will have to subsidise production to lower the market price to consumers, while still ensuring firms earn the minimum price of $5 (see topic to explain subsidies more fully). Figure.24 shows how the government must subsidise the price of milk by $4 per litre to increase quantity demanded to 2. This will increase consumer and producer surplus (which overlap), but result in deadweight loss associated with the subsidy. This is shown as the black triangle on the graph. Rent ($/litre) P 2 P Market for Milk Figure Minimum Prices & Allocative Efficiency MINIMUM PRICE Assuming that the government uses a subsidy to maintain a minimum price in a market, then there will be deadweight loss resulting from the subsidy. Consumer urplus P 2 Producer urplus eadweight Loss

37 THE THE MARKET AN AN ALLOCATIVE EFFICIENCY (.1) revision

38 98 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 This question checks that you can: show a subsidy and its effect on allocative efficiency show changes to allocative efficiency and deadweight loss explain how a subsidy affects different groups differently To improve people s health and reduce healthcare costs, the government has chosen to subsidise the installation of home insulation. Graph 1: The Market for Home Insulation Price UBIY Revision.1 ubsidy uantity (home installations) 1. On Graph, identify the market price and quantity before the subsidy (P 1, 1 ) and after the subsidy (P 2, 2 ). 2. On Graph 1 above, show the following as a result of a $1 500 subsidy on installation of home insulation. a. hade the change in producer surplus with horizontal lines b. hade the change in consumer surplus with dots: c. hade the loss of allocative efficiency resulting from the payment of the subsidy with vertical lines:

39 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 99. With reference to consumer and producer surplus, explain why producers benefit more from the subsidy on home insulation. In your answer: explain the effect of the subsidy on producers of home insulation explain the effect of the subsidy on consumers of home insulation explain why the price of home insulation does not fall by $1 500 per installation explain the effect that elasticty has on the government s goal of making home insulation more affordable for people wanting to install home insulation

40 100 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 This question checks that you can: describe the government policy of imposing a maximum price show the impact of a maximum price on allocative efficiency evaluate the effectiveness of a maximum price oaring house prices are causing a the price of rental housing, i.e. rent, to soar. To help low-income families, the Government is considering imposing a maximum rent. 1. Rent is the price paid by tenants for rental accommodation. escribe what maximum rent (price) is. Your answer should refer to the purpose of a maximum rent in relation to the market equilibrium price. Revision.2 Maximum Price Rent ($/week) P 1 P F Graph 2: The Market for Rental Housing F Maximum Rent uantity 2. The current weekly rental is show in Graph 2 as P 1. Assume that the Government sets a maximum rental of P F. After the imposition of the maximum rent, show: the quantity of rental housing that the government and consumers would like at the maximum rent ( G ) the quantity of rental housing that the market will provide at the maximum rent the deadweight loss resulting from the imposition of the maximum rent.

41 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) Evaluation the effectiveness of the Government imposing a maximum rent. In your answer: explain the effect of the maximum rent on suppliers of rental accommodation explain the effect of the maximum rent on consumers of rental accommodation explain the impact of the maximum rent on market forces in the market for rental accommodation, and equilibrium quantity evaluate the success of the Government s policy with regard to it achieving its goals of helping low-income families. Revision.2 Maximum Price

42 102 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 This question checks that you can: describe the government policy of imposing a tariff compare the impact of a tariff on different groups in a market explain the impact of a tariff on allocative efficiency evaluate the effectiveness of a tariff In 1987, tariffs on clothing ranged from 40-65%. By 1999 they were %. While beneficial to New Zealand consumers, the move was initially disastrous for local clothes manufacturers and their employees - where the number of jobs nearly halved over the same period. Graph : The New Zealand Market for Clothing Price ($) P 1 P T W+TARIFF Revision. Tariffs 1 Graph shows the New Zealand market for clothing with the tariffs on imported clothes in place (i.e. in 1987). 1. Using the New Zealand market for clothing as an example, explain the purpose of a tariff on imports. 2. At P T (with high tariffs in place) on Graph above, show: a. the quantity of cosmetics produced in NZ ( P ) b. the quantity of cosmetics consumed in NZ ( C ) c. the level of imports of cosmetics (M).. how the lowering of tariffs by adding a new supply curve ( W ). 4. how the impact of the lowering of tariffs by identifying on Graph : a. the new price (P W ) b. the new quantity consumed (c 1 ) and quantity produced by NZ (p 1 ) c. shading the loss in tariff revenue for the government from removing the tariff. d. the deadweight loss that resulted from the higher tariffs and no longer exists at W.

43 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) Evaluate the effectiveness of the government policy in the late 1980 s to lower tariffs on imported clothing. Your answer should include: In your answer: explain how market forces respond to the lowering of tariffs on imported clothes compare and contrast the impact of the lower tariffs on New Zealand consumers and producers explain the impact of the lower tariff on allocative efficiency in the market evaluate the overall success of the Government s policy with regard to to improving allocative efficiency in the market for clothing and in New Zealand generally Revision.5 ubsidy

44 104 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 This question checks that you can: describe the government policy of imposing a sales tax compare the impact of a sales tax on different groups in a market explain the impact of a sales tax on allocative efficiency evaluate the effectiveness of a sales tax An informal comparision of the price of wine in New Zealand and UA suggested that New Zealand consumers are paying considerably more for New Zealand wine that U consumers due to the high level of sales taxes on wine in New Zealand. Graph 4: Market for Wine Price ($/litre) 0 28 TAX Revision.4 ales Tax Assume the price of wine includes a sales tax of 7 per litre of wine. Graph 4 shows the supply of wine including the tax ( TAX ) and excluding the tax (). 1. With the tax included ( TAX ), state: uantity (million litres) a. the price consumers would pay per litre of wine $ b. the amount retailers will receive for themselves per litre if wine $ c. the reduction in wine sold in the market million litres Fully explain the effect of the tax on wine by calculating: a. the tax revenue received by the Government $ million b. the change in total consumer spending on wine $ million c. wine suppliers revenue if there was no sales tax () $ million d. wine suppliers revenue with the sales tax ( TAX ) $ million e. the change in Consumer urplus due to the tax $ million f. the value of the deadweight loss resulting from the sales tax $ million remember - try the exercises and then read the notes to learn what you don t know...

45 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) Explain the impact of the government imposing a sales tax on the allocative efficiency of the market for wine. Your answer should clearly: describe how market forces cause the imposition of a sales tax to change the market equilibrium price and quantity. explain why the market price for wine does not increase by the full amount of the sales tax explain the impact of the sales tax on allocative efficiency (i.e. consumer and producer surplus) in the market for wine compare and contrast the different impact of the sales tax on groups in the market (including consumers, producers and government) Revision.4 ales Tax

46 106 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 This question checks that you can: describe the impact of international trade on a market explain how market forces respond to international trade evaluate (compare and constrast) the impact of international trade on different groups in a market The growth in smartphones has led to an increase of small computer applications (app s) that are increasingly cheap to develop and market - both in New Zealand and internationally.. Graph 5: New Zealand Market for martphone App s Revision.5 International Trade Price ($) P 1 P 2 e a c Graph 5 shows the market for smartphone applications in New Zealand. 1. From Graph 5, identify the letter or letters that represent: b 1 2 d W Key = domestic supply W = world supply = domestic demand uantity a. Consumer surplus before trade b. Producer surplus after trade c. The quantity imported after trade d. The increase in allocative efficiency due to trade 2. Explain why the world supply curve ( W ) is drawn as a horizontal line.

47 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 107 Graph 6 shows the same market for smartphone applications in New Zealand. Price ($) Graph 6: New Zealand Market for martphone App s W Key = domestic supply = world supply = domestic demand P 1 P 2 W. On Graph 6, show the impact of an increase in domestic demand for smartphone app s by: a. showing the new demand curve ( 2 ) b. showing the increase in consumer surplus c. showing the new quantity of imported smartphone applications 4. Explain how the market for smartphone app s will respond to the increase in domestic demand. Your answer should clearly: 1 2 describe how market forces respond to the increase in domestic demand, and result in a new equilibrium quantity, but not price explain the impact of increased demand on consumer surplus uantity Revision.5 International Trade

48 108 THE MARKET AN ALLOCATIVE EFFICIENCY -.1 UNIT upply & emand Applications Unit Content:.1 International Trade how Market Equilibrium in a 2-Country Model Illustrate Trade Between New Zealand and the World how Changes to International Trade escribe International Protectionism how the Impact of Tariffs on Trade and Allocative Efficiency how the Impact of uotas on Trade and Allocative Efficiency.2 ales Tax escribe a ales Tax how the Effects of a ales Tax how the Impact of a ales Tax on Allocative Efficiency how and Compare the Incidence of a ales Tax on Consumers and Producers. ubsidy escribe a ubsidy how the Effects of a ubsidy how the Impact of a ubsidy on Allocative Efficiency how and Compare the Incidence of a ubsidy on Consumers and Producers.4 Fixed Prices escribe a Fixed Price how a Maximum Price how the Effect of a Maximum Price on Allocative Efficiency how a Minimum Price how the Effect of a Minimum Price on Allocative Efficiency 1 (poor) Understanding 2 (good) checklist: I have... done a mind-map of the main ideas (before and after I ve done the work) tried (and marked) all of the exercises watched the online videos of this work read the notes and summarised the key ideas in the margins of the pages made (or downloaded from quizlet) flashcards of the key ideas and definitions relevant current events and examples: relevant events and examples for this unit are: I didn t really get the following parts of this unit and I m going to ask to help me with this

49 THE MARKET AN ALLOCATIVE EFFICIENCY (.1) 109 tips 4 revision YouTube To help you with the material in this workbook, you can access video resources on YouTube. There is a wide variety of economic resources that you can search for. There are specific videos that have been created to go along with this workbook. Many of these videos relate to the notes. However there are also videos that show you how to do the exercises in this workbook. To find these, go online to and search the following keywords - dykesnz, economics. quizlet To help you revise, make revision resources through the year. At the start of the year, create your own uizlet ( account. As you finish each topic, create a set of flash cards for the definitions and concepts you must learn. ome sets have been created on uizlet for you (keywords - dykesnz, economics). how to study Too many students do bucket study, i.e. they think their mind is a bucket and if they just read their notes again... and again... and again... etc, they will fill their mind up with lots of facts, which they can then download during a test of exam. YOUR MIN I NOT A BUCKET. Revision does include some memorising or rote learning. But remember that you mind learns new stuff by forming patterns, so study in a way that supports this. There are three main types of revising: memorise In economics, and all of your courses, there will be some stuff that you do need to memorise. efinitions, key concepts, rules, formulae. The key to this is repetition. It s better to spend 2 minutes every hour doing some memorising, that one half-hour block per day. To help you make some flashcards, or download some digital flashcards (e.g. from uizlet) on to your phone. And then look at them between periods, or during ad breaks while watching tv. understand Most importantly you must understand the course and demonstrate this in a test or exam. Mindmaps are useful for this as they get you to work out how the different pieces of the course relate to each other, and help your brain form patterns. Mind-maps are also very good if you are a visual learner, as you will find it easier to remember a picture than lots of facts or definitions. practise The most effective way to revise is do past tests or exams. Use the exercises and revision activities in this book, or go to and download past exam questions and model answers. Check with your teacher about which ones to use as the standards changed in 201. As you do the tests or exams, identify what you don t know and go back to the notes to find the answers. Then redo the test and check your answers. Make sure you understand it correctly.