ECON 201
LECTURE
Government Policy &
Economic Welfare
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
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
Total Social Welfare
•
Ideally the impact of a program should be
evaluated as: {Pareto efficient}
•
•
•
•
1) can at least one person’s welfare be improved
2) without making anyone worse off
http://en.wikipedia.org/wiki/Pareto_efficiency
More realistically: Could the winners
compensate the losers? {Pigouvian}
•
•
Is the deadweight loss of the taxed good less than
the surplus gain from the subsidized good?
http://en.wikipedia.org/wiki/Pigovian_tax
Application:
Taxes and Competitive Equilibrium
• Consider a per-unit tax, which adds a fixed dollar
amount to each unit of a good sold.
• Graphically, the imposition of the tax is shown
by a leftward shift of the supply curve.
Figure 6.4 The Effect of a Per-Unit Tax
on Laptop Sales
Deadweight Loss
Price Consumers
Pay
Pre-tax price
Price Sellers
Receive
Reduction in
Qty sold
Deadweight Loss
Retained CS
Tax Rev
From CS
Tax Rev
From CS
Retained PS
Application:
Taxes and Competitive Equilibrium
• This example illustrates three key ideas related to
taxes:
• Incidence of a tax on consumers:
• The increase in price that consumers pay
• Incidence of a tax on producers:
• The decrease in price producers receive
• Deadweight loss:
• Losses in consumer and producer surplus that are not
transferred to the government as revenue
Elasticity and Tax Incidence
• The incidence of a tax will be determined by the
elasticities of demand and supply.
Figure 6.5(a)
Elasticity and Tax Incidence
Figure 6.5(b)
Elasticity and Tax Incidence
Tax Incidence and Demand Elasticity
• If demand is inelastic, the majority of
the tax incidence falls on consumers.
• If demand is elastic, the majority of the tax incidence falls
on producers.
• As demand elasticity increases, the deadweight loss
increases.
Figure 6.5(c)
Elasticity and Tax Incidence
Figure 6.5(d)
Elasticity and Tax Incidence
Tax Incidence and Supply Elasticity
• If supply is inelastic, the majority of the tax incidence falls
on producers.
• If supply is elastic, the majority of the tax incidence falls
on consumers.
• As supply elasticity increases, the deadweight loss
increases.
Quotas
• Quota—A maximum quantity of a good or service that can
be traded over a specific period of time.
• Used when the government determines
the equilibrium quantity would not be in society's best interest
• For example: International trade
Figure 6.9 The Effect of a Quota on the
Market for Laptop Computers
MV to Consumers
DWL from CS
DWL from PS
MC of resources
Quota Restriction
Equilibrium Qs
The Effects of a Quota
• Quotas result in:
• A transfer of surplus from consumers
to producers
• Deadweight loss (DWL)
• DWL is due to less being produced than would be in an unrestricted
(competitive) market
• Resources are underutilized and inefficiently allocated
• Consumers place a higher MV on good than MC of using resources to
produce the good
The UW and Quotas
• The UW has recently announced that it will not
accept any transfers for spring quarter
• Restriction on number of students being admitted <->
quota
• Assume that the market had previously been
efficient (Qs= Qd at current tuition fee)
• A) what would be the economic consequences of the
transfer “freeze”?
• B) what would be the impact of raising tuition, instead of
“freezing” transfers
• C) In real-life, how are the students admitted to the UW
determined (by what kind(s) of allocation schemes?
Another Quota Problem
• It is estimated that illegal immigrants account for about
25% of construction labor in the US housing market
• A) what would be the impact a ban on illegal immigrants on the
labor market for US housing construction, i.e., hourly wage rates?
• B) what would be the impact of this ban on the price of newly
constructed houses?