Microeconomics Module 2

Tax incidence is

The analysis, or manner, of how a tax burden is divided between consumers and producers

What does it look like when Indifference curves do not cross

The easiest way to prove this by showing what would happen if they did cross

How do interest rates affect household saving?

The interest rate determines the relative price of these two goods

What is a price floor?

a minimum price allowed by law

Why use price controls?

because of unfair market outcome; aimed at helping the poor

Increase in wages.....

budget constraint shifts outward and becomes steeper

small elasticity of demand is when

buyers do not have good alternatives to consuming this good

The slope of the labor-supply curve....

need not be the same at all wages

Binding contraint Price Ceiling

occurs when the government sets a required price on a good or goods at a price below equilibrium

Increase in Income = ?

outward shift

As wage rises.... (Income Effect)

purchasing power is increased

Other ways of helping those in need

rent and wage subsidies

If consume more today: Income effect dominates

save less

If consume less today: Substitution effect dominates

save more

Small elasticity of supply is when

sellers do not have good alternatives to producing this good

below the equilibrium price

shortage

Budget constraint shifts outward

steeper

What connects the indifference curve and the budget constraint?

tangent

Consumer surplus: 1

the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it

Marginal Buyer

the buyer who would leave the market first if the price were any higher

Optimum

the highest indifference curve the consumer can reach is the one that just barely touches the budget constraint

Relative Price

the price of one good in comparison with the price of other goods

If the price of ONLY one good changes...

the slope of the budget constraint changes

What happens at the optimum?

the slope of the budget constraint is equal to the slope of the indifference curve

Welfare economics: 1

the study of how the allocation of resources affects economic well-being

Introduce payroll tax is

the taxes employees and employers pay on wages, tips, and salaries

Why could the Government use taxes

to raise revenue for public projects

Perfect Complements

two goods with right-angle indifference curves - EX. right shoes and left shoes

Perfect Substitutes

two goods with straight-line indifference curves EX. bundles of nickels and dimes

If enjoy more leisure

work less

If you enjoy less leisure:

work more

What happens when there is a shift in the budget constraint

change in income

Why are higher indifference curves are preferred to lower ones?

consume more

Suppose government passes a law requiring sellers of ice-cream cones to send the government $0.50 for every cone they sell. How does this law affect the buyers and sellers of ice cream?

1. Must decide whether the law affects the supply curve or the demand curve 2. Must decide which way the curve shifts 3. Examine how the shift affects the equilibrium price and quantity

How taxes on sellers affect market outcomes

(1) Demand curve doesn't change. However, tax on sears makes the business less profitable, so the supply shifts (2) Tax on sellers raises the cost of production, so it reduces the quantity supplied at every price. So the supply curve shifts to the left. Market price now has to be higher to compensate for the tax and money lost by sellers. So supply curve shirts upwards as well (3) Equilibrium price raises, and quantity falls. Sellers sell less and Buyers buy less so the tax reduces the size of the ice-cream market

More leisure =

- Backward-sloping labor supply curve

Lawmakers

- Can decide whether a tax comes from the buyer's pocket or from the seller's - Cannot legislate the true burden of a tax

Willingness to pay

- Maximum amount that a buyer will pay for a good - Measures how much that buyer values that good

Impact of the minimum wage on highly skilled and experienced workers

- No effect: their equilibrium wages are well above the minimum - Minimum wage: non binding

Advocates of the minimum wage

- Raise the income of the working poor - Workers who earn the minimum wage can afford only a meager standard of living

Slope of the budget constraint

- Rate at which the consumer can trade one good for the other - Relative price of the two goods (1 pizza is worth 5 liters of Pepsi)

Indifference curve

- Shows consumption bundles that give the consumer the same level of satisfaction - The consumer is indifferent among points A, B, and C

Budget Contraint

- Shows the limit on the consumption bundles that a consumer can afford - It shows the trade-off between goods

What are extreme examples of indifference curves

- The shape of an indifference curve can reveal a lot - When the goods are easy to substitute for each other, the indifference curves are less bowed - When the goods are hard to substitute, the indifference curves are very bowed

If minimum wage is above equilibrium

- Unemployment - Higher income for workers who have jobs - Lower income for workers who cannot find jobs

Less leisure means

- Upward-sloping labor supply curve

Elasticity and tax incidence

- Very elastic supply and relatively inelastic Relatively inelastic supply -- Sellers bear most of the tax burden -- Buyers bear a small burden

Market for labor

- Workers supply labor - Firms demand labor

Four Properties of Indifference Curves

-Higher indifference curves are better - downward sloping, do not cross, bowed inward

Impact of the minimum wage on teenage labor

-Least skilled and least experienced -Low equilibrium wages -Willing to accept a lower wage in exchange for on-the-job training -Minimum wage: binding

Opponents of minimum wage

-not the best way to combat poverty -poorly targeted policy

Shifts in the Budget Constraint

-shows opportunities available to consumer -drawn given consumer's income and prices of two goods - the budget constraint shifts from consumer's income or price change

A lower price raises consumer surplus for two reasons:

1. Existing buyers: increase in consumer surplus (A) 2. New buyers enter the market: increase in consumer surplus (B)

How taxes on sellers affect market outcomes

1. Initial impact on the demand 2. Demand curve shifts left 3. Lower equilibrium price & lower equilibrium quantity - The tax reduces the size of the market - Buyers and sellers share the burden of tax - Sellers get a lower price, are worse off - Buyers pay a lower market price, are worse off -- Effective price (with tax) rises

What is the substitution effect?

If the price of one good increases, demand for a similar (substitute) good increases

Implied Rankings

A consumer's set of indifference curves gives a complete ranking of the consumer's preferences

Why should consumption rise?

Because both the income and substitution effects move in that direction

Why would the slope of the budget constraint stay the same?

Because the relative price of the two goods has not changed

Welfare economics: 2

Benefits that buyers and sellers receive from engaging in market transactions

Shifts the relative position of the supply and demand curves

Buyers and sellers share the tax burden

Consumer surplus: 3

Closely related to the demand curve

Elasticity and Tax Incidence

Determined by the forces of supply and demand

Policymakers - additional regulations

Difficult and costly to enforce

Fair Labor Standards Act of 1938

Ensured workers a minimally adequate standard of living

What is a normal Good

Good for which an increase in income raises the quantity demanded

What is an inferior Good

Good for which an increase in income reduces the quantity demanded

What comes with an increase in interest rates?

Higher interest rates make loans more expensive for both businesses and consumers

Welfare economics: 3

How society can make these benefits as large as possible

Welfare economics: 4

In any market, the equilibrium of supply and demand maximizes the total benefits received by all buyers and sellers combined

What can happen when Indifference curves are downward sloping

In most cases, the consumer would like more of both goods

If the two bundles suit their tastes equally well, we say that ___________ between the two bundles

Indifferent

Consumer surplus: 2

Measures the benefit buyers receive from participating in a market

Consumer's choices do not only depend on budget constraints; they also depend on?

Preferences regarding the two goods

not binding price ceiling

Price ceiling is set above the equilibrium price

At any quantity, the price given by the demand curve

Shows the willingness to pay of the marginal buyer

Marginal Rate of Substitution (MRS)

The rate at which a consumer is willing to trade one good for another

Wedge between the price that buyers pay and the price that sellers receive

The same, regardless of whether the tax is levied on buyers or sellers

Indifference curves are bowed inward toward the graph's origin

The slope of the indifference curve is the rate at which the consumer is willing to trade one good for another

What is the income effect?

a change in quantity demanded caused by a change in consumer income

What is a Giffen Good

a good for which an increase in the price raises the quantity demanded

What is a price ceiling?

a maximum price allowed by law

What is price control?

Two types, maximum price and minimum price.

How do wages affect labor supply?

When wages increase, the opportunity cost of leisure increases and people supply more labor

By law, the tax burden is

a measure of the tax burden imposed by government

What is tax incidence?

a measure of who ultimately pays a tax, either directly or through the tax burden

Tax burden is

amount of tax paid by a person, company, or country in a specified period considered as a proportion of total income in that period

Consumer surplus in a market

area below the demand curve and above the price

What is the law of demand?

as price increases, demand decreases

Income and Substitution effect

as your income goes up the want for substitute goes down and vice versa

The substitution effect could dominate at low wages and income effect....

could dominate at high wages

Payroll taxes

deducted from the amount you earned

lesiure

free time

How can the consumer reach a higher indifference curve?

increase in income

Decrease in income = ?

inward shift

As wage rises.... (Substitution Effect)

leisure becomes relatively more expensive

Rationing Mechanisms

long lines, discrimination according to sellers' biases

Price floor: Minimum Wage

lowest price for labor that any employer may pay