ECO 112 Introductory Microeconomics Quiz 2 Chapters 6, 10

not binding price ceiling

Above the equilibrium price No effect

binding price floor

Above the equilibrium price Surplus

Case Study: Lines at the Gas Pump

Before OPEC raised price of oil, EP was below price ceiling -> non-binding -> no effect OPEC reduced oil production Price of oil rose -oil is input of gasoline --> S curve shifts left Binding -> above new EP -> causes shortage -Price ceiling prevents price from reaching EP Laws regulating gas price were eventually repealed

Which side of the market bears the greatest tax incidence?

Inelastic side

Case Study: Who Pays the Luxury Tax

Luxury tax intended to affect rich Elastic demand and inelastic supply -> burden of tax falls on suppliers Firms and workers creating luxury good receive much lower price for product Burden of lux tax falls more on middle class than rich

Chapter 10 #9 (cont) B) How much higher would the costs of pollution reduction be if the permits could not be traded?

Total cost of pollution reduction = [((30-20) x $20) + (40-20) x $30) + (20-20) x $10)] = $800 Pollution reduction would cost $400 if the permits couldn't be traded

**READ CASE STUDIES & GRAPH THEM**

see figure 2 gas prices in 70s slide 15 - effects of minimum wage on labor market (ex. of binding price floor) -tax on sellers/buyers -slide 28: How the burden of a tax is divided

Dead weight loss (DWL)

waste of resources

not binding price floor

Below the equilibrium price No effect

In the News: The Coase Theorem in Action

Economic theory that says it doesn't really matter who's initially given a property right As long as you clearly define it and transaction costs are low, people will trade the right so that it ends up w/ whoever values it most

Case Study: Payroll Tax

FICA is a payroll tax Places a wedge between wage workers receive and wage firms pay Attempts to equally distribue tax between firms and workers Workers wages decrease Wage firms pay increase Workers and firms share tax burden regardless of which side the tax is levied But cannot legislate true burden of a tax; division of burden isn't necessarily 50/50

Qso and QM

Qso = socially optimal output or quantity QM = Market quantity

Dividing the tax burden - Relatively inelastic supply and very elastic demand

Sellers - most of the tax burden Buyers - small burden

Externality

Uncompensated impact of one person's actions on the well-being of a bystander -Market failure

effects of (binding) minimum wage on labor market

minimum wage is a price floor -> surplus Quantity of labor supplied > quantity demanded Results in unemployment

Dividing the tax burden - Very elastic supply and relatively inelastic demand

Sellers - small burden of tax Buyers - most of the burden

Dividing the tax burden - Extreme Case Side that's perfectly elastic

Side that's perfectly elastic has zero tax burden Very sensitive to price change

Positive externality

Impact on the bystander is beneficial Lead markets to produce a smaller quantity than is socially desirable

Negative production externality

Supply curve 1 = Private Cost curve Supply curve 2 (to the left of S1) = Social Cost curve Demand Curve = Social Value Social Cost > Social Value Qso > QM/EQ Externality = vertical distance between SC and PC DWL - triangle near distance between SC and SV on QM Government may internalize the externality by discouraging production

Effects of taxes on market outcomes (cont)

Taxes always discourage/decrease economic activity In most cases, taxes affect BOTH market sides, EVEN if the tax is called a consumption tax or a production tax Elasticity affects tax incidence/burden

Chapter 10 #9 There are three industrial firms in Happy Valley Initial Pollution level: Firm A: 30 units | B: 40 units | C: 20 units Cost of Reducing Pollution by 1 Unit Firm A $20 | B: $30 | C: $10 The government wants to reduce pollution to 60 units, so it gives each firm 20 tradable pollution permits A) Who sells the permits and how many do they sell? Who buys permits and how many do they buy? What is the total cost of pollution reduction?

A) Current total pollution is 90 units Must reduce pollution BY 30 units Firms with higher cost of reducing pollution will buy permits rather than reduce their pollution Firms that can sell their permits for more than it costs to reduce their pollution will Firm B is the most desperate and the net buyer Firm B buys 20 units from firm C b/c they offer the cheapest alternative --> has 40 pp in total so doesn't reduce pollution at all Firm C sells its 20 pp to firm B --> now has 0 pp Firm A keeps its 20 pp & neither buys nor sells Total cost of pollution reduction = [((30-20) x $20) + (40-40) x $30) + (20-0) x $10)] = $400

binding price ceiling

Below the equilibrium price (trying to lower EP -> protect consumers) Shortage

In the News: What Should We Do About Climate Change?

British Columbia increased carbon tax Reduces taxes for business and individuals US should also adopt similar tax: reduce existing tax laws, help environment and increase personal freedom and energy security Carbon tax can reduce economic drag and increase long-run economic growth If enacted by US, may lead to more tax reductions for everybody (individual and corporate income, real estate, etc) Promotes energy conservation and investment into clean technology and other productive economic activities Carbon tax makes sense for everyone

Tax on buyers

D curve shifts left EQ falls to Qt Price buyers pay increases Price sellers receives falls Tax = price buyers pay - price buyers receive Tax incidence (shaded triangle on diagram): top half is buyer tax burden; bottom is seller tax burden Even though the tax is levied on buyers, tax burden on both sides

Case Study: Minimum Wage

Free Labor Market -Workers determine supply of labor -Firms determine demand -W/o government intervention, wage normally adjusts to equilibrium Labor Market with Binding Minimum Wage -Price floor above EP -Q of labor supplied > Q labor demanded -Surplus of labor -> results in unemployment -greatest impact on the market for teenage labor limits

Case Study: Rent Control

Goal: make housing more affordable Short run -landlords have a fixed number of apartments -cannot adjust this number quickly as market conditions change -S & D are relatively inelastic -Price ceiling causes small shortage of housing -Primary effect: reduce rent Long run -As time passes, sellers and buyers respond more to market conditions -w/ low rents, landlords respond by: ---not building new apartments ---failing to maintain existing ones -Low rents encourage people to: ----find their own apartments ----induce more people to move to the city -S & D are more elastic -Rent control causes large shortage

Case Study: Why is Gasoline Taxed so Heavily?

High gas tax b/c prevents congestion -> take public transport, carpool, closer commute instead Decreases accidents by (indirectly) discouraging purchase of large or sport vehicles Discourages gas use b/c causes pollution: burning fossil fuels is a primary cause of global warming Gas tax reduces threat by discouraging gas use

Effects of taxes on market outcomes

Immediate impact on sellers Shift in supply curve to the left Higher equilibrium price Lower equilibrium quantity Tax reduces the size of the market

Negative externality

Impact on the bystander is adverse Lead markets to produce a larger quantity than socially desirable Ex. pollution, second hand smoking

Price ceiling

Legal maximum on the price at which a good can be bought or sold designed to protect consumers or buyers because EP is too high Ex. Rent control

Price floor

Legal minimum on the price at which a good can be bought or sold designed to protect consumers or b/c EP is too low Ex. minimum wage

Tax incidence

Manner in which the burden of a tax is shared among participants in a market Determined by elasticity

List 4 Externalities Know how to label private and social curves -Which cost/value is greater? Is QM or Qso greater? Label Externality on graph Label DWL on graph How does govt. internalize the externality?

PCE NCE PPE NPE

Tax on sellers

S curve shifts left EQ falls to Qt Price buyers pay increases Price sellers receives falls Tax = price buyers pay - price buyers receive Tax incidence (shaded triangle on diagram): top half is buyer tax burden; bottom is seller tax burden Even though the tax is levied on sellers, buyers and sellers share the burden of the tax

Dividing the tax burden - Extreme Case Side that's perfectly inelastic

Side that's perfectly inelastic covers all of the tax burden People will still buy despite changes in prices and quantity Perfectly inelastic demand

Positive production externality

Supply curve 1 = Private Cost curve Supply curve 2 (to the right of S1) = Social Cost curve Demand Curve = Social Value Social Value > Social Cost EQ/QM < Qso Externality = vertical distance between PC and SC DWL - triangle near distance between SV and SC on QM Government may internalize the externality by encouraging production

Negative consumption externality

Supply curve = social cost curve Demand Curve 1 = Private Value Demand Curve 2 (to the left of D1) = Social Value Social Cost > Social Value EQ/QM > Qso Externality = vertical distance between PV and SV DWL - triangle near distance between SC and SV on QM Government may internalize the externality by discouraging consumption

Positive consumption externality

Supply curve = social cost curve Demand Curve 1 = Private Value Demand Curve 2 (to the right of D1) = Social Value Social Value > Private Value EQ/QM < Qso Society is under consuming Externality = vertical distance between SV and PV curve DWL - triangle near distance between SV and SC on QM Government may internalize the externality by encouraging consumption

Case Study: Technology Spillovers, Industrial Policy, and Patent Protection

Technology spillovers benefit third parties Govt. may internalize positive externality by subsidizing production of tech Tax breaks for research and development Industrial policy - govt intervention that aims to promote enhancing industries May subsidize these industries Another way to deal w/ tech spillover: patent protection Patent laws protect rights of inventors by giving them exclusive use of their inventions for a period of time Patent internalizes externality -> property right on its invention -provides incentive to research and help advance tech