"Markets and Efficiency" Please respond to the following:
Analyze how taxes and subsidies impact market efficiency. Speculate if market
efficiency would be increased or decreased without issues of taxes and subsidies. Justify
your response.
A tax is a compulsory payment levied by a government on the individuals and corporations to
finance government activities that do not bring immediate benefit but at a later time. On the
other hand, a subsidy is a monetary assistance granted by a government to a person or group
in support of an enterprise regarded as being in the public interest. In both case they distort
market efficiency when they prevent the forces of demand and supply to operate to achieve
the equilibrium market prices and quantity that will be fair to consumers. In the absence of
taxes and subsidy, the decision of market participant achieves efficiency but as they are
applied by government it changes either the price or the quantity that allow maximum gains
from the exchange of goods and services. An addition of tax to the price of goods and
services makes the product less attractive to the consumer and may decide to resort to
alternatives. In the same way a subsidy on say, agric products also let the competitive market
quantity to be less than what the subsidy offer. In this way output level become greater than
the efficient amount since the marginal cost of the farm product will exceed its marginal
social benefit. Without taxes and subsidy market efficiency will be increase and bring about
more net benefit for any product to be produce, thus, reduce prices in the case of taxes and
bring quantity produce to the level at which prices will be equal to their marginal cost
(Hyman, 2011).
Tax subsidies are the result of selective tax legislation one that benefits particular groups of
people or industries in the economy. In effect, they share the costs of certain actions between
the private sector and the government and impact investment decisions by increasing the
expected returns associated with a particular pattern of economic activity. Tax subsidies may
be applied in a number of ways to any one or a combination of economic variables
Governments often subsidize private enterprises or operate their own enterprises at a loss,
using taxpayer funds to make up the difference. Taxes can impair market efficiency, and so
can subsidies. Suppose the government guarantees farmers a certain price for their crops.
When the market price falls below the “target” price guaranteed by the government, the
government will pay eligible farmers a subsidy equal to the difference between the market
price of the product and the target price. Farmers know that they will receive the target price.
In deciding how much to plant, they will base their decision on the target price rather than the
market price when they believe that the target price will exceed the market price. As a result
of the target price program, more than the efficient amount of resources are devoted to the
production of wheat. Therefore, the loss in net benefits results from the subsidy-induced
distortion in resource use. When a product or a service is taxed, the amount that is traded is
influenced by the tax paid per unit, as well as by the marginal social benefit and marginal
social cost of the item.The tax distorts the decisions of market participants. For example,
income taxes influence the decision workers make about the allocation of their time between
work and leisure.
Market efficiency occurs through the forces of the invisible hand to incentivize producers and
consumers to use every possible resource available to produce goods and services for the
market. When government provides subsidies or imposes taxes, the invisible hand is
prevented from setting prices and quantities efficiently. Some goods and services will be
increased and others decreased from their efficient point. It is very important to note that
"efficient" only means that resources are being used fully, it does NOT mean that they are
being used optimally. While government intervention will make the economy less efficient, it
often results in improving the quality of life of those living in the economy.
Market efficiency would be increased without issues of taxes and subsidies. When money is
put into the stock market, it is done with the aim of generating a return on the capital
invested. Many investors try not only to make a profitable return, but also to outperform, or
beat, the market. Explain the trade-off between equity and efficiency. Identify how
individuals and organizations are likely to change their behavior as a result of government
actions. Taxes are a form of revenue generally used to fund government spending. Subsidies
on the anther hand are benefits given to businesses, groups and individuals in monetary form.
Taxes serve as revenue and Subsidies server as expenses for the government. Market
efficiency is achieved essential when resources are used to benefit individuals but no one
person is better off than another person. The absence of taxes and subsidies would cause the
market efficiency to decrease b/c without taxes revenue would not be available to assist those
that need assistance, thus creating an inefficient market. The adverse affect would ultimately
create market failure. Government intervention is needed to provided effiency as long as their
is not misappropriation of spending. This type of misappropriation or lack of taxes and
subsidies will result in a lack of resources, which decreases market efficiency.
Explain the trade-off between equity and efficiency. Identify how individuals and
organizations are likely to change their behavior as a result of government actions.
Efficiency means that for any good or service marginal social benefit equals marginal social
cost. Equity refers to the fairness of obtaining goods and services among individuals.
People’s opinions differ on what is fair and what is not fair. The tradeoff between the two is
illustrated in our text with the utility possibility curve. This analyzes highest level of
wellbeing for everyone in the economy without sacrificing the needs of one person for the
needs of another. The main issue is the difference in resources amongst the wealthy and the
poor. The poor is often employed at lower wages and has little or no education. The
government helps these individuals obtain public assistance with funds from taxes and
subsidies.
An economic situation in which there is a perceived tradeoff between the equity and
efficiency of a given economy. This tradeoff is commonly viewed within the context of the
production possibility frontier, where any additional gains in production efficiency must be
offset by a reduction in the economy's equity. Equity-efficiency tradeoff occurs in an
economy when additional gains in production efficiency must be offset by reduction in
economy's equity. Within this equity and efficiency tradeoff, equity refers to the economy's
financial capital, while efficiency refers to the future efficiency in the production of goods
and services. This theory asserts that, in order for a nation to become wealthier, it must save
its equity. However, these additional savings will hurt the development of more efficient
production in the future. Individuals must be ready to bear the additional cost of living due to
a fall in economy and organizations must hire efficient people and manufacturing method to
cope with demand.
Efficiency is not the only criterion used to evaluate resource allocation. Many citizens argue
that outcomes should also be evaluated in terms of equity; that is, in terms of the perceived
fairness of an outcome. Improvements in efficiency are often opposed vigorously by specialinterest groups that would suffer losses if the improvements were enacted. These groups are
concerned with protecting their income shares at the expense of reduced output and wellbeing in the economy as a whole. Changes in policy that move the economy toward
efficiency are often opposed because they result in a change in income distribution.
Individuals opposing actions that improve efficiency act rationally.
Equity consist of fair benefits for society. Efficiency takes in consideration of limited
resources to benefit society. The tradeoff between equity and efficiency would be cost.
Efficiency is consist when benefits equal cost. The tradeoff between the two would be cost.
To promote fairness while at the same time attempting to be efficiencies can be costly. To
redistribute resources accordingly requires capital and someone has to finance the transaction,
thus someone will go without.
Efficiency exists when resources are used over any given period of time in such a way as to
make it impossible to increase the well-being of any one person without reducing the wellbeing of any other person. And equity arises when there is fairness in the market system such
that all groups of persons are treated fairly with the distribution of resources available. But
efficiency moves in a situation of having adequate resources distribution among all groups.
When some group of people have the resource allocation to embark on efficient production at
the expense of another, efficiency ceases to exist and the issue of equity losses it importance,
thus, there is a trade-off between efficiency and equity. That is, wherever one maximize gains
from efficient allocation of resources another person is made worse off. Often, individuals or
organizations who are the losers because of lack of resources to achieve efficiency seek for
government support to either block the distribution of wealth as is associated with capitalism
to redistribute income so as to ensure equitable distribution of income to either lessen or even
eradicate the supremacy of equity and efficiency (Hyman, 2011).
References
Hyman, D. N. (2011). Public Finance. Mason: South-Western Cengage Learning.