Chapter 4 Microeconomics

The Economic Effect of Taxes

"Taxes are what we pay for a civilized society" When the government taxes a good or service, however, it affects the market equilibrium for that good or service Just as with a price ceiling or a price floor, one result of tax is a decline in economic efficiency Analyzing taxes is an important part of the field of economics known as public finance

Conclusion

- markets free from government intervention eliminate surpluses and shortages and do a good job of responding to the wants of consumers both consumers and firms sometimes try to use the government to change market outcomes in their favor the concepts of consumer surplus, producer surplus, and deadweight loss allow us to measure the benefits consumers and producers receive from competitive market equilibrium These concepts allow us to measure the effects of government price floors and price ceilings and the economic effect of taxes

Economic Surplus and Economic Efficiency

Consumer surplus measures the benefit to consumers from buying a particular product Producer surplus measures the benefit to firms from selling a particular product Economic surplus is the best measure we have of the benfit to society from the production of a particular good or service Economic surplus gives us a second way of characterizing the economic efficiency of a competitive market Equilibrium in a competitive market results in the greatest amount of economic surplus, or total net benefit to society, from the production of a good or service anything that causes the market for a good or service not to be in competitive equilibrium reduces the total benefit to society from the production of that good or service

Price Ceilings: Government Rent Control Policy in Housing Markets

Support for government setting price floors typically comes from sellers, and support for governments setting price ceilings typically comes from consumres a price ceiling reduces economic efficeincy

Price Floors: Government Policy in Agricultural Markets

The Great Depression was the worst economic disaster in US history, affecting every sector of the economy Many farmers could sell their products only at very low prices, so they convinced the federal government to set price floors for many agricultural prodcuts Government intervention in agriculture (often called the farm program) has continued ever since The federal government's farm programs have often resulted in large surpluses of wheat and other agricultural products -in response, the government has usually either bought the surplus food or paid farmers to restrict supply by taking some land out of cultivation Because both of these options are expensive, Congress passed the Freedom to Farm Act of 1996 -the intent of the act was to phase out price floors and government purchases of surpluses and return to a free market in agriculture -to allow farmers time to adjust, the federal government began paying farmers subsidies, or cash payments based on the number of acres planted -Although the subsidies were orignally scheduled to be phased out, Congress has passed additional farm bills that have resulted inthe continuation of subsidies requiring substantial federal government spending -

Normative Analysis

What ought to be

Black Markets and Peer-to-Peer Sites

When governments regulate prices by enacting price ceilings or price floors, buyers and sellers often find a way around the regulations

Tax Incidence: Who Actually Pays a Tax?

Whoever is legally required to send a tax payment to the government pays the tax there can be an important difference between who is legall required to pay the tax and who actually bears the burden of the tax

The Efficiency of Competitive Markets

a competiive market is a market with many buyers and many sellers an important advantage of the market system is that is results in efficient economic outcomes we can think of economic efficiency in terms of marginal benefit and marginal cost, and also think in terms of consumer surplus and producer surplus (both will lead to the same outcome, but using both can increase our understanding of economic efficiency)

Black Market

buying and selling take place at prices that violate government price regulations

Tax Incidence

the actual division of the burden of a tax between buyers and sellers

Deadweight Loss

the reduction in economic surplus resulting from a market not being in competitive equilibrium

Economic Surplus

the sum of consumer surplus and producer surplus in a competitive market, with many buyers and sellers and no government restrictions, economic surplus is at a maximum when the market is in equilibrium

Government Intervention in the Market: Price Floors and Price Ceilings

we have not concluded that every individual is better off if a market is at competitive equilibrium have concluded only that economic surplus, or the total net benfit to society, is greatest at competitive equilibrium any individual producer would rather receive a higher price, and any individual consumer would rather pay a lower price, but usually producers can sell and consumers can buy only at the competitive equilibrium price Producers and consumers who are dissatisfied with the competitive equilibirum price can lobby the government to legally require that producers charge a different price in the US, the government only occasionally overrides the market outcome by setting prices When the government does intervene, it can attempt to aid either sellers by requiring that a price be above equilibrium ( a price floor) or aid buyers by requiring that a price be below equilibrium ( a price ceiling) To affect the market outcome, the government must set a legal price floor that is above the equilibrium price or set a legal price ceiling that is below the equilibrium price -otherwise, the price ceiling or price floor will not be binding on buyers and sellers

Positive Analysis

what is Economics focuses on positive analysis Analysis of rent control and the economic results of these programs -whether these programs are desirable or undesirable is a normative question Whether the gains to the winners more than make up for the losses to the losers and for the decline in economic efficiency is a matter of judgment and not strictly an economic question Price ceilings and price floors continue to exist partly because people who understand their downside still believe they are good policies and therefore support them The policies also persist because many people who support them do not understand the economic analysis in this chapter and so do not understand the drawbacks of these policies

Positive and Normative Analysis of Price Ceilings and Price Floors

Are rent controls, government farm programs, and other price ceilings and price floors bad? - Questions of this type do not have right or wrong answers Economists are generally skeptical of government attempts to interferde with competitive market equilibrium Economists know the role competitive markets have played in raising the average person's standard of living -they also know that too much government intervention has the potential to reduce the ability of the market system to produce similar increases in living standards in the fturue

Consumer Surplus and Producer Surplus

Consumer surplus measures the dollar benefit consumers receive from buying goods or services in a particular market Producer surplus measures the dollar benefit firms receive from selling goods or services in a particular market Economic surplus in a market is the sum of consumer surplus and producer surplus When the government imposes a price ceiling or a price floor, the amount of economic surplus in a market is reduced Price ceilings and price floors reduce the total benefit to consumers and firms from buying and selling in a makret

What Consumer Surplus and Producer Surplus Measure

Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. That is, if the price of a product were zero, the consumer surplus in a market would be all of the area under the demand curve. When the price is not 0, consumer surplus is the area below the demand curve and above the market price. Consumer surplus in a market is equal to the total benefit consumes receive minus the total amount they must pay to buy the good or service Producer surplus measures the net benefit received by producers from participating in a market. If producers could supply a good or service at 0 cost, the producer surplus in a market would be all of the area below the market price. When cost is not 0, producer surplus is the area below the market price and above the supply curve. So, producer surplus in a market is equal to the total dollar amount firms receive from consmres minus the cost of producing the good or service.

The Result of Government Price Controls: Winners, Losers, and Inefficiency

When the government imposes price floors or price ceilings, three important results occur: 1. Some people win. -the winners from rent control are the people who are paying less for rent because they live in rent-controlled apartments. Landlords may also gain if they break the law by charging rents above the legal max for their rent-controlled apartments, provided that those illegal rents are higher than the compettive equilibrium rents would be. 2. Some people lose. - The losers from rent control are the landlords of rent-controlled apartments who abide by the law and renters who are unable to find apartments to rent at the controlled price 3. There is a loss of economic efficiency Rent control reduces economic efficiency because fewer apartments are rented than would be rented in a competitive market. The Resulting deadweight loss measures the decrease in economic efficiency.

The Effect of Taxes on Economic Efficiency

Whenever a government taxes a good or service, less of that good or service will be produced and consumed The federal government will collect tax revenue equal to the tax per good x the number of goods sold When consumers are paying a higher price, there is a loss of consumer surplus When the price producers receive falls, there is a loss of producer surplus the trude burden of a tax is not just the amount consumers and producers pay the government but also includes the deadweight loss a tax is efficient if it imposes a small excess burden relative to the tax revenue it raises one contribution economists make to government tax policy is to advice policymakers on which taxes are most efficient

Marginal Benefit Equals Marginal Cost in Competitive Equilibrium

demand curve shows the marginal benefit received by consumers, and the supply curve shows the marginal cost of production For this market to achieve economic efficiency, the marginal benefit from the last unit sold should equal the marginal cost of production Equilibrium in a competitive market result in the economically efficient level of output, at which marginal benefit equals marginal cost

Consumer Surplus

difference between the highest price a consumer is willing to pay for a good or service and the actual price the consumer pays We can use the demand curve to measure the total consumer surplus in a market Demand curves show the willigness of consumers to purchase a product at different prices Consumers are willing to purchase a product up to the point where the marginal benefit of consuming a product is equal to its price The total amount of consumer surplus in a market is equal to the area below the demand curve and above the market price Represents the benefit to consumers in excess of the price they paid to purchase a product

Economic Efficiency

market outcome in which the marginal beneift to consumers of the last unit produced is equal to its marginal cost of production and in which the sum of consumer surplus and producer surplus is at a maximum

Peer-to-Peer Sites

sometimes renters and landlords don't actually abide by the price ceiling because rent control leads to a shortage of apartments, renters who would otherwise not be able to find apartments have an incentive to offer landlord rents above the legal maximum online peer-to-peer rental sites like Airbnb have provided landlords and tenants another way to avoid rent controsl -landlors can use these sites to convert a regular yearly rental into a series of short-term rentals for which they can charge above the legal maximum rent -tenants can also use the sites to make a profit from rent controls some government officials in both NYC and San Fran were reluctant to take actions that might limit the growth of the sharing economy of peer-to-peer rental sites -the sharing economy has the potential to improve economic efficiency and make available to consumer goods at lower prices when cities have rent control laws, though, peer-to-peer sites perform a somewhat different function, making apartments available at rents higher than the legal price ceiling (apartments that renters might otherwise have difficulty finding because of the shortage caused by rent control) -remains to be seen whether local policymakers can resolve the conflict between putting legal ceilings on rents and encouraging peer-to-peer sites to operate in their cities rent controls can also lead to an increase in racial and other types of illegal discrimination With rent controls, more renters are looking for aprartments than there are apartments to ent landlords are more likely to indulge their prejudices by refusing to rent to people from groups they don't like, even if doing so is illegal In cities without rent controls, landlords face more competition, which makes it more difficult to reject tenants on the basis of irrelevant characteristics, such as race

Producer Surplus

supply curves show the willingness of firms to supply a product at different prices the willingness to supply a product depends on the cost of producting it firms will supply an additional unit of a product only if they receive a price equal to the additional cost of producing that unit the difference between the lowest price a firm would be willing to accept for a good or service and the price it actually receives the total amount of producer surplus in a market is equal to the area above the market supply curve and below the market price

Marginal benefit

the additional benefit to a consumer from consuming one more unit of a good or service

Marginal cost

the additional cost to a firm of producing one more unit of a good or service Often, the marginal cost of producing a good increases as more of the good is produced during a given period of time Increasing marginal cost is the key reason that supply curves are upward sloping

excess burden

the deadweight loss from a tax is called the excess burden of the tax

Does it make a difference whether the government collects a tax from buyers or sellers?

the incidence of a tax does not depend on whether the government collects a tax from the buyers of a good or from the sellers People don't keep track of their purchases and the government doesn't check whether they sent this info to them and are paying all the taxes they owe. That is why the government collects the tax on gasoline from sellers.