Download Lecture_03.1 Government Intervention

Econ 100
Fall 2010
Lecture 3.1
Government Policy &
Economic Welfare
10-12-10
Assignments
• Homework #2: due 10-14
• Readings: Ch. 4
• Additional readings
– CATO Institute: “Milk Madness”
• Practice Quiz
– http://facweb.northseattle.edu/dperry/econ100
/exams and grades/econ 100 quiz 1 fall
2009.rtf
• Quiz #1: Th 10/14 or Tu 10/19?
Evaluating the Impact of
Government Intervention
• Policy Instruments Available
– Taxes
• Typically: per-unit tax on output
• Others: lump-sum, value added (VAT)
– Subsidies
• Rebate on per-unit produced
– Price Floors
• Minimum price that can be charged (e.g., minimum wage)
– Price Ceilings
• Limit on the maximum price that can be charged (WIN)
– Quotas
• Limits on amounts produced/imported
• Infant industry/protectionism
Key Assumptions
• No Market Failure
– No externalities
• i.e., benefits or costs that are not accounted for in
the marketplace (e.g., no free riders, no pollution
costs that aren’t captured in the product’s price)
– Perfectly competitive markets
• Large # of suppliers and buyers
• Evaluate Market Efficiency
– Look at losses/gains in consumer/producer
surplus
Effect of a Tax on the Supply Curve
• To the supplier: increases per-unit costs
– Shifts supply curve to the left
• Reduces amount supplied and raises the
market clearing price
• How do we measure the effects of the tax?
– Efficiency or deadweight losses are losses in
consumer and producer surplus relative to the
“ideal” market
How Do We Analyze the Effects of
Taxes and Subsidies
• The efficient ideal market
– “perfectly competitive” market
• Consumers and suppliers are price-takers, i.e. have no
market power
Effect of a Tax on the Supply Curve
Deadweight Loss
How Do We Evaluate
the Impact of the Tax?
• Two Parts:
– Tax Incidence
• Who pays for it more?
– Consumers or Producers?
– Will depend on relative demand/supply elasticities
– Economic welfare analysis
• Does the tax (revenue) improve social welfare?
– Will depend on relative elasticities of:
» a) good taxed
» B) good or program financed by the tax
Tax Incidence
• Essential question is: how much of the tax
can be passed on to consumers?
– Suppliers will be able to a higher proportion of
the tax onto consumers when
• Demand is relatively inelastic
• Supply is relatively elastic
– Under these conditions
• Consumer surplus losses >> producer surplus
losses
Economic Welfare Analysis
• Framework for analysis is comparing
benefits and costs
– Costs of the tax
• Reduction in equilibrium quantity
• Increase in price paid
– Costs can be calculated as the deadweight
loss in $ if demand and supply curves are
known
Evaluating The Impact
• Costs:
– Deadweight loss: sum of reduction in consumer and
producer surplus for the taxed good
• Reflects reduction in Qd and higher price paid
So Do They Do This
in the Real World?
• The Senate has approved a bill that would
require gasoline producers to blend 36 billion
gallons of ethanol into gasoline by 2022, an
increase from the current standard of 7.5 billion
gallons by 2012. The House did not include such
a provision in the version it passed, and it is
uncertain whether any final legislation will
emerge this year and what it will say about
ethanol if it does.
• What would be the impact of such legislation on
the demand for ethanol? For corn-based food
prices?
Price Floors
• A price floor is a government or group imposed limit on
how low a price can be charged for a product.
– For a price floor to be effective, it must be greater than the
equilibrium price.
Examples of Price Floors
• Minimum wage
– Can create a surplus of labor
• Agricultural price supports
– Every year, farmers produce and sell a certain product at a
certain price that is determined by the market. If the market price
is lower than that price at which the farmers want to sell, the
farmers are in a deficit. Therefore, in order to assist American
farmers, our government gives price supports for some crops
and dairy products. So in a case where the market price is lower
that the target price for farmers, farmers receive a "deficiency
payment", or price support, from the government in order to
make up for the difference.
– Has created a surplus of cheese and milk products
• Some released to low-income/poverty households
• Can exacerbate the effect by increasing supply
An Economist’s Perspective
• Cato Institute
– http://www.cato.org/pubs/tbb/tbb_0707_47.pdf
• The federal government has subsidized and regulated
the dairy industry since the 1930s. A system of
“marketing order” regulations was enacted in 1937. A
dairy price support program was added in 1949. An
income support program for dairy farmers was added in
2002.
• As part of this year’s farm bill, Congress may reauthorize
dairy programs, but they are among the most illogical of
all farm programs.1 The government spends billions of
dollars reducing food costs through programs such as
food stamps, yet dairy programs increase milk prices.
Price Ceilings
• A price ceiling is a government-imposed limit
on how high a price can be charged on a
product. For a price ceiling to be effective, it
must differ from the free market price
– Example:
• New York City rent control
– Landlords are not allowed to raise rental prices
• Gerald Ford’s Whip Inflation Now (WIN)
• World War II
– Somewhat effective (resulted in blackmarkets, rationing)
– Impact:
• Shortages and higher costs
Welfare Effects of Rationing
Quotas
• A restriction of limit on:
– The number of migrant workers that can be
legally employed in the US
– The amount of a good or resource that can be
imported to the US, or exported from the US
– The amount of a resource that can be
“harvested” during a period of time (e.g., fish
or mining)
– The amount of a pollutant that can be emitted
– The number of taxi cabs that can be licensed
Trade Quotas
•
•
•
Import quotas are limitations on the quantity of goods that can be imported
into the country during a specified period of time. An import quota is
typically set below the free trade level of imports. In this case it is called a
binding quota. If a quota is set at or above the free trade level of imports
then it is referred to as a non-binding quota. Goods that are illegal within a
country effectively have a quota set equal to zero. Thus many countries
have a zero quota on narcotics and other illicit drugs.
There are two basic types of quotas: absolute quotas and tariff-rate quotas.
Absolute quotas limit the quantity of imports to a specified level during a
specified period of time. Sometimes these quotas are set globally and thus
affect all imports while sometimes they are set only against specified
countries. Absolute quotas are generally administered on a first-come firstserved basis. For this reason, many quotas are filled shortly after the
opening of the quota period. Tariff-rate quotas allow a specified quantity of
goods to be imported at a reduced tariff rate during the specified quota
period.
In the US in 1996, milk, cream, brooms, ethyl alcohol, anchovies, tuna,
olives and durum wheat were subject to tariff-rate quotas. Other quotas
exist on peanuts, cotton, sugar and syrup.
Useful Websites
• http://www.sjsu.edu/faculty/watkins/taximpact.html
•
•
•
•
•
•
•
•
•
•
•
Economic Welfare Analysis
Price Controls
Monopoly
Monopsony
Taxes and Subsidies
Oligopoly
Marginal Cost Pricing
Price Discrimination
Trade
Externality Tax
Something to Think About
Congress is currently considering an energy bill
which would mandate that all gasoline producers
use include at least 10% ethanol in each gallon
of gas
– 1. What would be the impact of this on the gasoline
market?
– 2. What would be the impact of this on the ethanol
market?
– 3. Impact on the corn market (for both food and
gasoline)?
– 4. Impact on the food products containing corn
market?
A Potential Short Answer
Question
– Assuming that the support is effective, what would be
the economic welfare impact on the milk market?
– The US government also provides food stamps to
subsidize food purchases. What is the impact of the
food stamp program (alone) on economic welfare?
– What can you say about the combined impact of both
the price support and food stamp programs on
economic welfare?