Outline. Introduction. ciency. Excise Tax. Subsidy 2/29

Transcription

1 2/29 Outline Introduction ciency xcise Tax Subsidy

2 3/29 Where have we come from? Part I I Consumers have a set of preferences over a basket of goods I Consumers choose the basket of goods that is a ordable and maximizes their utility max X,Y U(X, Y ) s.t. p x X + p y Y apple I

3 3/29 Where have we come from? Part I I Consumers have a set of preferences over a basket of goods I Consumers choose the basket of goods that is a ordable and maximizes their utility Part II max X,Y U(X, Y ) s.t. p x X + p y Y apple I I Firms are able to transform inputs into output using a given production technology I They choose the inputs mix that minimizes the cost of making a given output quantity min K,L wl + rk s.t. Q = f (K, L)

4 4/29 Where have we come from? Part II, cont. I Firms are assumed to be price takers I After optimizing the input mix, the firm chooses the output quantity which maximizes the firm s profit. max Q PQ TC(Q) I The firm shuts down production if price falls below the shut-down price (unable to cover their non-sunk costs) I In the short-run, the plant size and number of firms in an industry is fixed! upward sloping supply I In the long-run, firm s choose optimal plant size and operate at the minimum e cient scale. Firms can enter/exit the industry! zero economic profit

5 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention?

6 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes)

7 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes) I Subsidy: The opposite of an excise tax, the government pays money to a firm (consumer) for the production (consumption) of a good (e.g., vaccines)

8 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes) I Subsidy: The opposite of an excise tax, the government pays money to a firm (consumer) for the production (consumption) of a good (e.g., vaccines) I Price ceiling: The government fixes a maximum price for a good (e.g., rent controls)

9 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes) I Subsidy: The opposite of an excise tax, the government pays money to a firm (consumer) for the production (consumption) of a good (e.g., vaccines) I Price ceiling: The government fixes a maximum price for a good (e.g., rent controls)

10 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes) I Subsidy: The opposite of an excise tax, the government pays money to a firm (consumer) for the production (consumption) of a good (e.g., vaccines) I Price ceiling: The government fixes a maximum price for a good (e.g., rent controls) I Quotas (Production/Import): The government restricts quantity of a good in the market in order to increase price (e.g., agricultural markets)

11 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes) I Subsidy: The opposite of an excise tax, the government pays money to a firm (consumer) for the production (consumption) of a good (e.g., vaccines) I Price ceiling: The government fixes a maximum price for a good (e.g., rent controls) I Quotas (Production/Import): The government restricts quantity of a good in the market in order to increase price (e.g., agricultural markets) I Tari s: A tax levied specifically on imported goods to restrict goods coming from other countries

12 5/29 What s Next In this chapter, we look at the e ect of government interventions in a perfectly competitive market. What are the types of government intervention? I xcise Tax: Tax on a specific commodity (e.g., cigarettes) I Subsidy: The opposite of an excise tax, the government pays money to a firm (consumer) for the production (consumption) of a good (e.g., vaccines) I Price ceiling: The government fixes a maximum price for a good (e.g., rent controls) I Quotas (Production/Import): The government restricts quantity of a good in the market in order to increase price (e.g., agricultural markets) I Tari s: A tax levied specifically on imported goods to restrict goods coming from other countries

13 6/29 Introduction I These policies typically make some people better o and some people worse o. It is important to understand who are the winners and losers so you can understand the policy debates that take place. I All of the analysis in this chapter is done as a partial equilibrium analysis

14 7/29 Introduction Partial quilibrium Analysis: Ananalysisthatstudiesthe determination of equilibrium price and output in a single market, taking as given the prices in all other markets.

15 7/29 Introduction Partial quilibrium Analysis: Ananalysisthatstudiesthe determination of equilibrium price and output in a single market, taking as given the prices in all other markets. General quilibrium Analysis: Ananalysisthatdeterminesthe equilibrium prices and quantities in more than one market simultaneously

16 7/29 Introduction Partial quilibrium Analysis: Ananalysisthatstudiesthe determination of equilibrium price and output in a single market, taking as given the prices in all other markets. General quilibrium Analysis: Ananalysisthatdeterminesthe equilibrium prices and quantities in more than one market simultaneously I For example - If apartments are rent controlled, could this a ect the prices in the housing market?

17 7/29 Introduction Partial quilibrium Analysis: Ananalysisthatstudiesthe determination of equilibrium price and output in a single market, taking as given the prices in all other markets. General quilibrium Analysis: Ananalysisthatdeterminesthe equilibrium prices and quantities in more than one market simultaneously I For example - If apartments are rent controlled, could this a ect the prices in the housing market? I Changes in one sector often spill over into other sectors

18 7/29 Introduction Partial quilibrium Analysis: Ananalysisthatstudiesthe determination of equilibrium price and output in a single market, taking as given the prices in all other markets. General quilibrium Analysis: Ananalysisthatdeterminesthe equilibrium prices and quantities in more than one market simultaneously I For example - If apartments are rent controlled, could this a ect the prices in the housing market? I Changes in one sector often spill over into other sectors I If airline prices between NYC and Boston ", could this a ect train prices?

19 8/29 Another Assumption No xternalities - add this to the list of assumptions about perfectly competitive markets I xternality: the e ect that an action of any decision maker has on the well-being of another consumer or producer, beyond the e ects transmitted by changes in prices I xample Negative xternality- Pollution produced by a firm negatively e ects your health, but firm doesn t pay you to compensate you for this negative e ect I xample Positive xternality - Vaccination, the more people who are vaccinated the less likely you are to get the disease, you aren t paying those who got vaccinated for the benefits that accrue to you In this, chapter, we will use Consumer Surplus to measure consumer s welfare and Producer Surplus to measure producer welfare

20 9/29 conomic Hand ciency in a Competitive Market - Invisible A key feature of a Perfectly Competitive Market I In equilibrium, it allocates resources e ciently Note: Requires all of our assumptions from Ch. 9 I Perfect Information (Lemon Problem) I No one firm/consumer has market power (Monopoly/Monopsony) I No externalities

21 10/29 What do we mean by e cient? All desired trading has been accomplished I All benefits from trade have been exhausted (this issue is taken up in more detail in Ch. 16) I Can t make someone better o without making someone worse o (Pareto cient) Let s take a look at a graph to see why competitive market is e cient

22 11/29 ciency in Competitive quilibrium P $20 S $2 D Q

23 11/29 ciency in Competitive quilibrium P $20 Competitive quilibrium: P =8 Q =6 At point S $8 $2 6 D Q

24 11/29 ciency in Competitive quilibrium P What about welfare? $20 S $8 $2 6 D Q

25 11/29 ciency in Competitive quilibrium P $20 What about welfare? Consumer Surplus (1/2)(20 8)(6) = $36 S $8 $2 6 D Q

26 11/29 ciency in Competitive quilibrium P $20 What about welfare? Consumer Surplus (1/2)(20 8)(6) = $36 Producer Surplus (1/2)(8 2)(6) = $18 Total Surplus = $36 + $18 = $54 S $8 $2 6 D Q

27 11/29 ciency in Competitive quilibrium P What if eq. was 4 million units? $20 $12 $8 A S $6 B $2 4 6 D Q

28 11/29 ciency in Competitive quilibrium P $20 What if eq. was 4 million units? - Consumer willing to pay $12 - Producer willing to sell for $6 $12 $8 A S $6 B $2 4 6 D Q

29 11/29 ciency in Competitive quilibrium P $20 What if eq. was 4 million units? - Consumer willing to pay $12 - Producer willing to sell for $6 - They should make the trade, and exchange one more unit $12 $8 A S $6 B $2 4 6 D Q

30 11/29 ciency in Competitive quilibrium P $20 Total Surplus could increase by: Change in Total Surplus (1/2)(12-6)(2)=$6 $12 $8 A S $6 B $2 4 6 D Q

31 11/29 ciency in Competitive quilibrium P What if eq. was 7 million units? $20 $9 $8 $6 F G S $2 6 7 D Q

32 11/29 ciency in Competitive quilibrium P $20 What if eq. was 7 million units? - Consumer willing to pay $6 - Producer willing to sell for $12 $9 $8 $6 F G S $2 6 7 D Q

33 11/29 ciency in Competitive quilibrium P $20 What if eq. was 7 million units? - Consumer willing to pay $6 - Producer willing to sell for $12 - They should not make the trade, and exchange one less unit $9 $8 $6 F G S $2 6 7 D Q

34 11/29 ciency in Competitive quilibrium P $20 Total Surplus could increase by: Change in Total Surplus (1/2)(9-6)(1)=$1.5 $9 $8 $6 F G S $2 6 7 D Q

35 11/29 ciency in Competitive quilibrium P When demand curve is above supply curve: $20 Total Surplus increases if output rises S $8 $2 6 D Q

36 11/29 ciency in Competitive quilibrium P When demand curve is below supply curve: $20 Total Surplus increases if output falls S $8 $2 6 D Q

37 12/29 ciency in Competitive quilibrium =) Any production level above/below Q =6willleadtoa lower amount of surplus than the competitive equilibrium I The Invisible Hand: We came to this e cient allocation by 1. Consumers acting in self-interest to maximize utility 2. Producers acting in self-interest to maximize profit I No one told the consumers and producers how to act, there was no social planner =) The equilibrium output produced when everyone was acting in their own self-interest is one that maximizes net economic benefits (Total Surplus) as long as we are in a perfectly competitive market

38 13/29 xcise Tax What is it? I Tax on a specific commodity How does it work? I Suppose government imposes a $6 per unit tax on gasoline I Now what consumer pays (P d ) and amount the sellers receive (P s ) di ers ( tax wedge ) I More generally: P d = P s + T P d = P s +6 I Let s imagine that the seller has the administrative responsibility of collecting the tax and giving it to the government

39 14/29 quilibrium with an xcise Tax P Competitive quilibrium $20 S 0 $8 $2 6 D Q

40 14/29 quilibrium with an xcise Tax P Supply Shifts " with Tax $20 S 0 +6 S 0 $8 $2 6 D Q

41 14/29 quilibrium with an xcise Tax P $20 quilibrium with Tax: P d = $12 P s = $6 Q =4 S 0 +6 M $12 $8 S 0 $6 N $2 4 6 D Q

42 14/29 quilibrium with an xcise Tax P Let s see what happens to Welfare $20 S 0 +6 M $12 $8 S 0 $6 N $2 4 6 D Q

43 14/29 quilibrium with an xcise Tax P Let s see what happens to Welfare Consumer Surplus=$12 (-$24) $20 S 0 +6 M $12 $8 S 0 $6 N $2 4 6 D Q

44 14/29 quilibrium with an xcise Tax P Let s see what happens to Welfare Consumer Surplus=$12 (-$24) Producer Surplus=$8 (-$10) $20 S 0 +6 M $12 $8 S 0 $6 N $2 4 6 D Q

45 14/29 quilibrium with an xcise Tax P $20 Let s see what happens to Welfare Consumer Surplus=$12 (-$24) Producer Surplus=$8 (-$10) Tax Revenue=$24 $12 $8 $6 M N S 0 +6 S 0 $2 4 6 D Q

46 14/29 quilibrium with an xcise Tax P $20 Let s see what happens to Welfare Consumer Surplus=$12 (-$24) Producer Surplus=$8 (-$10) Tax Revenue=$24 Deadweight Loss=$6 $12 $8 $6 M N S 0 +6 S 0 $2 4 6 D Q

47 15/29 Outcomes - xcise Tax 1. Market underproduces relative to e cient level (smaller Q) 2. Price the consumer pays increases ($8! $12) 3. Price suppliers receive decreases ($8! $6) 4. Consumer Surplus and Producer Surplus both fall 5. Some of this decrease is received by the government in the form of tax revenue 6. Some of this decrease is deadweight loss (gains from exchange that used to happen that is no longer happening)

48 16/29 Deadweight Loss Deadweight Loss: A reduction in net economic benefits resulting from an ine cient allocation of resources. I xchange that would have taken place that doesn t due to the tax wedge causing a di erence in supplier and consumer price

49 17/29 Practice: Impact of an xcise Tax This example is the algebraic version of the graph we just analyzed. Suppose demand and supply are given as follows: Q d = 10 ( Q s = 0.5P d 2+P s, P s 2 0 P s < 2 where Q d is the quantity demanded when the price consumers pay is P d,andq s is the quantity supplied when the price producers receive is P s. a) With no tax, what are the equilibrium price and quantity? b) Suppose the government imposes an excise tax of $6 per unit. What will the new equilibrium quantity be? What price will buyers pay? What price will sellers receive?

50 18/29 Incidence of a Tax Assume a downward sloping demand and upward sloping supply curve Incidence of a tax: A measure of the e ect of a tax on the price consumers pay and sellers receive in the market I Both Consumers & Sellers are a ected no matter who collects the tax I Consumer price paid " I Seller price received # I But - Who shares more of the burden? I Let s examine two cases of a $10 tax

51 19/29 Case1: Incidence of a Tax Demand is Relatively Inelastic Compared with Supply

52 20/29 Case 2: Incidence of a Tax Supply is Relatively Inelastic Compared with Demand

53 21/29 Incidence of a Tax Case 1: Relatively Inelastic Demand I Consumer price rises a lot: $8 I Producer price decreased just a little: $2 I Why: Consumer s demand is inelastic so can handle large changes in price without adjusting quantity by very much Case 2: Relatively Inelastic Supply I Consumer price rises a little: $2 I Producer price decreased a lot: $8 I Why: Producer s supply is inelastic so can handle large changes in price without adjusting quantity by very much

54 22/29 Incidence of a Tax How can we calculate this? P d P s = Q s,p Q d,p How the tax a ects consumers relative to producers can be described by the ratio of the price elasticity of supply to the price elasticity of demand

55 23/29 xample - Incidence of a Tax xample 1: Suppose Q s,p =0.5, Q d,p = levied. What is the incidence of the tax? 0.5, and a $2 tax is Q s,p Q d,p = = 1= Pd P s A ratio of 1 means the tax is shared equally between consumers and producers. So, with a $2 tax, the consumer price will " $1 and the producer price # $1

56 24/29 xample - Incidence of a Tax xample 2: Suppose Q s,p =2.0, Q d,p = levied. What is the incidence of the tax? 0.5, and a $2 tax is Q s,p Q d,p = = 4= Pd P s The increase of price to consumers is 4x that of producers. So, with a $2 tax, you can get the incidence by dividing tax by 5 (2/5=0.4). The consumer price will " $1.60 (0.4 4) and the producer price # $0.40 (0.4 1). You could also solve this system of equations: 4 P s = P d P d P s =2

57 25/29 Incidence of a Tax - Cigarettes Consider the case of cigarettes I What you think demand is? I I lastic Inelastic I What do you think supply is relative to demand? I I lastic Inelastic Who bears more of the burden of a cigarette tax?

58 26/29 Subsidy What is it? I Instead of taxing, government pays each seller a subsidy of $X per unit How does it work? I Now, consumer pays (P d ) and amount the seller receives (P d + X ) P s = P d + X I How to model this? TC NS = Q + Q 2 =) MC =2+2Q TC S = Q + Q 2 XQ =) MC =2+2Q X Marginal cost curve is reduced (lowers supply curve)

59 27/29 quilibrium with a Subsidy X =$3 P Competitive quilibrium $20 S 0 $8 $2 6 D Q

60 27/29 quilibrium with a Subsidy X =$3 P Supply Shifts # with Subsidy $20 S 0 $8 S 0 3 $2 6 D Q

61 27/29 quilibrium with a Subsidy X =$3 P $20 quilibrium with Subsidy: P d = $6 P s = $9 Q =7 $9 $8 $6 R U S 0 S 0 3 $2 6 7 D Q

62 27/29 quilibrium with a Subsidy X =$3 P Let s see what happens to Welfare $20 $9 $8 $6 R U S 0 S 0 3 $2 6 7 D Q

63 27/29 quilibrium with a Subsidy X =$3 P Let s see what happens to Welfare Consumer Surplus=$49 (+$13) $20 $9 $8 $6 R U S 0 S 0 3 $2 6 7 D Q

64 27/29 quilibrium with a Subsidy X =$3 P $20 Let s see what happens to Welfare Consumer Surplus=$49 (+$13) Producer Surplus=$24.5 (+$6.5) $9 $8 $6 R U S 0 S 0 3 $2 6 7 D Q

65 27/29 quilibrium with a Subsidy X =$3 P Let s see what happens to Welfare Consumer Surplus=$49 (+$13) Producer Surplus=$24.5 (+$6.5) Subsidy Cost=$21 $20 $9 $8 $6 R U S 0 S 0 3 $2 6 7 D Q

66 27/29 quilibrium with a Subsidy X =$3 P Let s see what happens to Welfare Consumer Surplus=$49 (+$13) Producer Surplus=$24.5 (+$6.5) Subsidy Cost=$21 Deadweight Loss=$1.5 $20 $9 $8 $6 R U S 0 S 0 3 $2 6 7 D Q

67 28/29 Outcomes - Subsidy 1. Market overproduces relative to e cient level (larger Q) 2. Price the consumer pays decreases ($8! $6) 3. Price suppliers receive increases ($8! $9) 4. Consumer Surplus and Producer Surplus both increase 5. The increase is paid for by the government (subsidy cost) 6. However, the subsidy costs more than the total gain in consumer and producer surplus leading to a deadweight loss

68 29/29 Practice: Impact of a Subsidy As before, demand and supply are given by: Q d = 10 ( Q s = 0.5P d 2+P s, P s 2 0 P s < 2 a) Suppose the government provides a subsidy of $3 per unit. Find the equilibrium quantity, the price buyers pay, and the price sellers receive.