Download Principles of Economics I week 4 – chapters 7,8 and 12

Principles of Economics I
week 4 – chapters 7,8 and 12
Hana Džmuráňová
[email protected]
Info – outline of seminars
Week (Winter)
1
Day (2016)
5 th October
2
Lecturer: Hana Džmuráňová
12 th October
Lecturer: Hana Džmuráňová
3
19 th October
Lecturer: Hana Moravcová
4
26 th October
5
Lecturer: Vědunka Kopečná
2 nd November
Lecturer: Hana Džmuráňová
6
9 th November
7
Lecturer: Hana Džmuráňová
16 th November
8
Lecturer: Vědunka Kopečná
23 th November
9
Lecturer: Vědunka Kopečná
30 th November
Lecturer: Hana Moravcová
10
7 th December
11
Lecturer: Hana Moravcová
14 th December
Lecturer: Hana Moravcová
12
21 st December
Lecturer: Vědunka Kopečná
Themes
Book chapters
Ten Principles o f Economics; 1 + 2
Thinking Like an Economist
The Market Forc es o f Supply 4 + 5
and D emand; El asticity and Its
Application
Supply,
Dem and
and 6 + 21
Governm ent
Policies;
The
Theory of Consumer Choice
cancelled
Consumer s, Produc ers, and the 7 + 8 + 12
Efficiency o f Markets; , The
Costs of Taxation; The D esign of
the Tax System
Extern alities; Public Goods and 10 + 11
Common Resources
The Co sts o f Production; Firms 13 + 14
in Competitive Markets
Monopoly;
Oligopoly; 15 + 16 + 17
Monopolistic Competition
The Markets for th e Factors of 18 + 19
Production;
Earnings
and
Discrimination
Income Inequality and Poverty
20
Interdep end ence and the Gains 3 + 9
from Trade; International Trade
Frontiers of Microeconomics
22
Outline
• Consumers, producers, and the efficiency of
markets (chapter 7)
• The cost of taxation (chapter 8)
• The Design of the Tax System (chapter 12)
Markets and welfare
• Welfare economics is the study of how the allocation of resources affects economic well-­‐being.
• Welfare economics is concerned with how to maximize well-­‐being
• Question of how to maximize well-­‐being across consumers/producers
• Social planner’s problem: how to allocate resources such that welfare is maximized?
– How to know how much individuals really value a good?
• Equilibrium in the market results in maximum benefits, and therefore maximum total welfare for both the consumers and the producers of the product.
Surplus – two views
• Consumer surplus aka buyer‘s side = personal value of good (how much a consumer is willing to pay) – amount paid
• Producer surplus aka seller‘s side = price sold – cost of production (measures benefit from market participation)
Question – who paid attention in the
morning gets ½ point?
• A demand curve reflects each of the following except the
– A) willingness to pay of all buyers in the market.
– B) value each buyer in the market places on the good.
– C) highest price buyers are willing to pay for each quantity.
– D) ability of buyers to obtain the quantity they desire.
Question – who paid attention in the
morning gets ½ point?
• Consumer surplus is the
– A) amount of a good consumers get without paying anything.
– B) amount a consumer pays minus the amount the consumer is willing to pay.
– C) amount a consumer is willing to pay minus the amount the consumer actually pays.
– D) value of a good to a consumer.
Consumer surplus
Small number of buyers –
demand has a staircase shape
Consumer surplus
Small number of buyers –
demand has a staircase shape
P = 80 -­‐> John‘s consumer surplus = 20
Consumer surplus
Small number of buyers –
demand has a staircase shape
P = 70 -­‐> John‘s consumer surplus = 30
Paul‘s consumer surplus = 10
Total consumer surplus = All individual
consumer surpluses = 40
Smooth Demand curve (1)
• Lots of buyers
• CS = area of blue triangle = ½ x base x height
Smooth Demand curve (2)
• Decrease in price -­‐> What happens with
consumer surplus?
Smooth Demand curve (2)
• Decrease in price -­‐> higher CS for initial
consumers + some CS for new consumers
Exercise – ½ point
Buyer
Four consumers in a Carlos
market have following Quilana
willingness to pay for Wilbur
an Iphone cover:
Willingness to Pay
$15
$25
$35
Ming-­‐la $45
If the market price for the good is $25, who will purchase the good?
A) Ming-­‐la only
B) Carlos and Quilana only
C) Quilana and Wilbur only
D) Quilana, Wilbur, and Ming-­‐la only
And who is marginal buyer? Does he/she have any surplus?
Producer surplus
Small number of sellers –
supply has a staircase shape
Y-­‐axis – cost of production as well as price received
Grandma – costs is 500
Georgina – cost is 600
Producer surplus
Small number of sellers –
supply has a staircase shape
P = 600 -­‐> Grandma‘s producer
surplus = 100
Producer surplus
Small number of sellers –
supply has a staircase shape
P = 800 -­‐> Grandma‘s
producer surplus = 300
Georgia‘s producer surplus = 200
Total producer surplus = All
individual producer surpluses = 500
Smooth Supply curve (1)
• Lots of sellers
• PS = area of red triangle = ½ x base x height
Smooth Supply curve (2)
• Increase in price -­‐> what happens with
producer surplus?
Smooth Supply curve (2)
• Increase in price -­‐> higher PS for initial
producers + some PS for new producers
Supply + Demand
Total surplus = CS + PS = value to buyers – costs to sellers
Value to buyer and seller
Equity vs. Efficiency
• Efficiency – maximization of surpluses
• Is market outcome desirable? PS and CS can
tell us
• Efficient market allocates resources to maximize surpluses BUT market can fail
• Social planner also cares about equity (fair distribution of resources)
Exercise
There are four consumers willing to pay the following
amounts for haircuts:
Jerry: $7 Oprah: $2 Sally Jessy: $8 Montel: $5
There are four haircutting businesses with the following
costs:
Firm A: $3 Firm B: $6 Firm C: $4 Firm D: $2
Each firm has the capacity to produce only one haircut.
• For efficiency, how many haircuts should be given?
• Which businesses should cut hair, and which consumers
should have their hair cut? How large is the maximum possible total surplus?
Use table and supply and demand curves to answer.
Exercise 1
Price
QS
QD
0
0
4
1
0
4
2
1
4
3
2
3
4
3
3
5
3
3
6
4
2
7
4
2
8
4
1
9
4
0
10
4
0
Exercise 1
Equilibrium ó Qs = Qd
Price
QS
QD
0
0
4
1
0
4
2
1
4
3
2
3
4
3
3
5
3
3
6
4
2
7
4
2
8
4
1
9
4
0
10
4
0
Exercise 1
Exercise 1
Exercise 1
• Three haircuts are supplied at a price somewhere between $4-­‐5.
• Supplied by firms A, C and D to Jerry, Sallie-­‐
Jessie and Montel. • Total surplus = $11
Review
• At equilibrium, consumer surplus is measured by the area
– A) AHG.
– B) AFB.
– C) ABD.
– D) BDF.
Review
• At the equilibrium price, producer surplus is
• a. $600.
• b. $900. • c. $1,200.
• d. $1,800.
Review
• If the government imposes a price floor of $90 in this market, then consumer surplus will be
• a. $225.
• b. $450.
• c. $975.
• d. $1,350
Question – who paid attention in the
morning gets ½ point?
• Suppose that the government imposes a tax of P3 -­‐ P1.
• The price that sellers effectively receive after the tax is imposed is
– A) P1.
– B) P2.
– C) P3.
– D) P4.
Question – who paid attention in the
morning gets ½ point?
• Suppose that the government imposes a tax of P3 -­‐ P1.
• The tax causes a reduction in consumer surplus that is represented by area
– A) A.
– B) B+C.
– C) C+H.
– D) F.
Question – who paid attention in the
morning gets ½ point?
• Suppose that the government imposes a tax of P3 -­‐ P1.
• The benefit to the government is measured by
– A) tax revenue and is represented by area A+B.
– B) tax revenue and is represented by area B+D.
– C) the net gain in total surplus and is represented by area B+D.
– D) the net gain in total surplus and is represented by area C+H.
Tax and Surplus
Tax and Surplus
Tax and Surplus
What is consumer, producer and total surplus
before and after tax?
How do we call red triangles C and E?
Tax and Surplus
Deadweight loss and elasticity
A government is planning to impose a tax to raise revenue to offset its budget deficit. With reference to price elasticity of demand outline what type of good the government should levy the tax on if it wants to maximise
revenue and reduce deadweight loss to a minimum? ?
Deadweight loss and elasticity
Demand is given
How will supply elasticity affect DWL?
Deadweight loss and elasticity
Supply is given
How will demand elasticity affect DWL?
Exercise 2
• Tom walks Bethany’s dog once a day for $50 per week. Bethany values this service at $60 per week, while the opportunity cost of Tom’s time is $30 per week. The government places a tax of $35 per week on dog walkers. After the tax, what is the loss in total surplus?
– A) $50 – B) $30 – C) $25
– D) $0
Exercise 3
Who will bear higher tax burden in the following case and how will suplly and demand diagram look like?
Inelastic demand for leather Zara jacket and Zara
Exercise 3
Who will bear higher tax burden in the following case and how will suplly and demand diagram look like?
Inelastic demand for leather Zara jacket and Zara
Tax revenue as taxes vary
• Area of green rectangle
• Small tax x medium tax – higher taxes imply
higher DWL
Tax revenue as taxes vary
• Area of green rectangle
• Medium tax x large tax
Tax revenue as taxes vary
• How much is DWL increasing with each
increase in tax?
Tax revenue as taxes vary
• Laffer curve – Tax revenue with regard to tax size
• What does it say?
Review
• The deadweight loss from a tax
– A) does not vary in amount when the price elasticity of demand changes.
– B) does not vary in amount when the amount of the tax per unit changes.
– C) is larger, the larger is the amount of the tax per unit.
– D) is smaller, the larger is the amount of the tax per unit.
Exercise 4
Suppose that a market is described by the following supply and demand equations: Qs = 2P
Qd = 300–P a) Solve for the equilibrium price and the equilibrium quantity.
b) Suppose that a tax of T is placed on buyers, so the new demand equation is Qd = 300 – (P + T). Solve for the new equilibrium. What happens to the price received by sellers, the price paid by buyers, and the quantity sold?
c) Tax revenue is T*Q. Use your answer to part (b) to solve for tax revenue as a function of T. Graph this relationship for T between 0 and 300. Exercise 4 cont. (covered on seminar 6) d) The deadweight loss of a tax is the area of the
triangle between the supply and demand curves. Recalling that the area of a triangle is 1⁄2*base*height, solve for deadweight loss as a function of T. Graph this
relationship for T between 0 and 300. Exercise 5 (covered on seminar 6)
Fill out the table below assuming that the government taxes 20 percent of the first €30,000 of income and 50 percent of all income above €30,000. Exercise 5
• Compare the taxes for someone earning €10,000 to those of someone earning €50,000 in part (a) above. Is this tax system progressive, regressive, or proportional? Explain.