Download 5 2015-5 Long Run and Short Run Issues

Long Run and Short Run
Issues :The Role of Policy
In the long run all issues are changeable but in the
short run some elements are fixed.
The process of adjustment is the target for government
policies to influence outcomes that improve welfare.
The devices that governments use vary but basically
deal with either prices through regulation or taxation or
quantity through supply management techniques such
as quotas or prescriptions.
The policy role that governments use depends on
various pressures not all of which come from the
marketplace. Political, social, foreign and financial
pressure can also alter government policy.
Techniques of Policy
• Governments may use:
-regulation through contraband (Alcohol,Tobacco) or
market entry barriers (FIRA)or quotas
-taxation (direct [GST] or indirect [Income Tax])
-subsidies through grants [ WEDC, ALCOA,
etc.]
-prescriptions by setting minimum standards
including pricing, registration and performance
standards (labeling, etc.)
In all cases there is a either a short or long run risk of
creating a deadweight welfare loss that affects all of
society.
Contraband and Market Entry
Barriers
• Contraband means that a good or service is
illegal and is often set in place by international
agreement. It is generally defined as one in
which the Cost of supply is set so high that it
eliminates the market completely.
• Market entry barriers are set so that suppliers
must pay a very high market entry price and in
the process transfers most of the business
surplus to suppliers and also may eliminate the
market completely.
Contraband
•
Penalty level must be set at 0:Pme to eliminate the market
Price
Supply
Pme
Demand
0
Quantity
.
Market Entry Barriers
•
Market Entry Barriers must be set so that producers must incur costs [0:Pmeb] so that they can
only enter the market after the saturation point. Sometimes these include investing in other
markets.
Price
Demand
Supply
0
Saturation Point
Pmeb
Quantity
Adjustments to Contraband and
Market Entry Barriers
• In the long run supply may or may not
adjust:
- for contraband by shifting to the black
market and carrying on business
illegally.
- for market entry barriers by market
abandonment (leaving), creating local
subsidiaries that diversify (manipulating
transfer pricing regimes), or by political
influence (bribery).
Direct and Indirect Taxation
• Direct Taxation affects a particular good or
transaction and may be considered as an
increase in costs if the producer pays and an
decrease in income if the consumer pays it.
• Indirect taxation markets relates to general
taxation and may be applied to either producers
or consumers or both.
• Note: this relates to the market perspective
and is the mirror image of the common
political interpretation of direct taxation
(income tax) and indirect taxation (GST).
Direct Taxation on Consumers (1)
•
A tax on buyers shifts the demand curve downward by the level of the tax and its
metric. (flat or proportional)
Price
Price Buyers Pay
TAX
Price Without Tax
A FLAT TAX ON CONSUMERS
REDUCES QUANTITY.
Price Sellers Receive
Quantity
Quantity Sellers Offer
Equilibrium Quantity
Direct Taxation on Consumers (2)
•
•
A tax on buyers shifts the demand curve downward by the level of the tax and its
metric. (flat or proportional)
Price
Price Buyers
Pay
Demand 1
A PROPORTIONAL INCREASING TAX
ON CONSUMERS
DEMAND 1 TO DEMAND 2
REDUCES QUANTITY
TAX
Price Without Tax
Price Sellers
Receive
Demand 2
Quantity Sellers Offer
Tax rate increases
as quantity increases
Quantity
Equilibrium Quantity
Direct Taxation on Consumers (3)
•
•
A tax on buyers shifts the demand curve downward by the level of the tax and its
metric. (flat or proportional)
Price
Demand 2
A PROPORTIONAL DECREASING TAX
(SUBSIDY) ON CONSUMERS
DEMAND 1 TO DEMAND 2
INCREASES QUANTITY
Price Producers
Receive
Price Without Tax
Demand 1
SUBSIDY
Price Consumers Pay
Tax rate decreases
as quantity increases
Equilibrium Quantity
Quantity Sellers Offer (1)
Quantity
Indirect Taxation
• Indirect taxation refers to taxes placed on
suppliers or others who are involved in the
market. This often happens in terms of
income tax credits and rely on:
- confidence in the taxing government
maintaining the appropriate tax regime
- the value of a tax deduction or other
type of credit in the future
- the persistence of the technology that
uses or values that product.
Adjustments to Direct and Indirect
Taxation
• In the long run direct or indirect taxation will
lead to markets shifting away from the product or
towards the product and in the process
reconfiguring the technological background
against which the market functions.
• Often the long term adjustment removes the
“perceived political” need for a market
intervention before the burden of taxation or
subsidy or deductions escalate.
Government Prescriptions
• Governments can use their “market control
power” to set standards such as maximum
pricing or quotas or pursue policies of
enforcement or education. (External Factors)
• These prescriptions depend on the elasticity of
the supply and demand as does the long term
adjustment which generally goes from inelastic
to elastic for supply and reverse for demand.
(Internal Factors)
Maximum Pricing: Price Ceilings
and Price Floors
•
At A price ceiling is too high and creates a surplus, at B it is too low and creates a
shortage.
Price
Supply
A
Surplus
Shortage
B
Demand
Quiantity
External Factors Affecting Supply
•
Market adjustments may arise due to autonomous supply changes such as crop failures or cartels
restricting market supply (Supply 2) and a surplus may become a shortage and visa versa.
Supply 2
Supply
Supply
Set Price
Demand
Demand
Surplus
Short Run
Shortage
Long Run
External Factors Affecting Demand
•
Market adjustments may arise due to autonomous demand changes such as education programs or enforcement
of standards (Demand 2) and a surplus may become a shortage and visa versa.
Supply
Demand
Supply
Set Price
Demand 2
Demand
Surplus
Short Run
Shortage
Long Run
Internal Factors Affecting Supply
•
Ease of entry or exit from the industry or adjustments in “definitions” may alter the
elasticity of supply and expand or contract either a surplus or a shortage.
Supply
elastic
Supply
Inelastic
Set Price
Demand
Demand
Shortage 2
Shortage
Short Run
Long Run
Internal Factors Affecting Demand
Educational initiatives and enforcement of patent law expirations can flatten demand as consumers
accept the product as a necessity and hence expect competition to increase substitutes and also
to stabilize prices thereby reducing demand elasticity and modifying surpluses or shortages.
Supply
Supply
Set Price
Demand
inelastic
Demand
elastic
Shortage
Short Run
Shortage
Long Run
Adjustments to Government
Prescriptions
• In general government prescriptions set standards that
can aggravate surpluses or shortages and in so doing
reduce quantities or expand quantities beyond the
market capacity.
• This results in a deadweight loss:
-Resources are utilized inefficiently and some get
more than they should while others get less
-Government becomes involved in
redistributing wealth to favored sectors that
would probably not survive on their own.
-Factor inputs , especially natural resources, are
exploited rather than managed as part of the natural
endowment of the nation.
Microeconomic Policy
• Often policies are set for one purpose but have
unintended effects on many other areas.
• Markets will adjust without government
interference but will do so in ways that may not
be acceptable to governments.
• It is up to economists to point out diseconomies
and to ensure that government responses are
transparent in order to make the market work for
the benefit of all.