Lecture 8 – Contents 1. Review Price controls Taxes 2. More on taxes

Lecture 8 - Contents 1. Review Price controls Taxes 2. More on taxes www.phwiki.com

Lecture 8 – Contents 1. Review Price controls Taxes 2. More on taxes

Patterson, Thomas, Music Director has reference to this Academic Journal, PHwiki organized this Journal Principles of Microeconomics 7. Taxes, Subsidies, in addition to Introduction to Welfare Analysis Akos Lada July 29th, 2014 Slide content principally sourced from N. Gregory Mankiw “Principles of Economics” Premium PowePoint Lecture 8 – Contents Review of previous lecture More on taxes Willingness to pay in addition to consumer surplus Costs in addition to producer surplus 1. Review

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Price controls Binding vs. non-binding constraints. Binding price ceilings (e.g. rent control) Leads to shortage Effect is more severe in the long run Rationing, in as long as mal market, decrease in quality Binding price floors (e.g. minimum wage) Leads to surplus (under the assumptions of the model Quiz: Refer to the labor market graph below. The imposition of an $8 minimum wage would cause tax revenues to increase by $2 per worker. unemployment of 35 labor hours. a labor shortage of 35 labor hours. no change in the equilibrium wage in addition to employment because the minimum wage is not binding. Do you support minimum wage laws How do you think economists would answer this question support strongly support mildly have mixed feelings oppose mildly oppose strongly

Do you support minimum wage laws How do you think economists would answer this question 1. support strongly 2. support mildly 3. have mixed feelings 4. oppose mildly 5. oppose strongly ANSWERS: 1. support strongly – 28.4% 2. support mildly – 18.9% 3. have mixed feelings – 14.4% 4. oppose mildly – 17.8% 5. oppose strongly – 20.5% SOURCE: Daniel B. Klein in addition to Charlotta Stern. “Economists’ Policy Views in addition to Voting.” Public Choice (2006) 126: 331-342. Taxes What shifts If imposed on buyers, it is equivalent to a decrease in income, shifts the dem in addition to curve left If imposed on sellers, it is equivalent to an increase in input costs, shifts the supply curve left What is the size of the shift The amount of the tax Tax incidence (who pays as long as the tax burden) Whether the tax is charged to the producers or to the sellers is irrelevant – the tax incidence is the same in both cases What matters is the elasticity of Supply in addition to Dem in addition to If Supply is more inelastic, the larger share of the burden falls on the sellers. If Dem in addition to is more inelastic, the larger share of the burden falls on the buyers 2. More on taxes

1. What shifts If imposed on buyers, it is equivalent to a decrease in income, shifts the dem in addition to curve to the left If imposed on sellers, it is equivalent to an increase in input costs, shifts the supply curve left $10 500 $10 500 2.What is the size of the shift For a $ 1.50 tax imposed on buyers ~ The amount of the tax! ~ For a $ 1.50 tax imposed on sellers $8.50 $7.50 $6.00 900 $1.5 (tax) 300 300 $12 $13.50 $1.5 (tax) 900 PS= P= PB= PB= P= 3.Who pays the tax burden For a $ 1.50 tax imposed on buyers $10 500 For a $ 1.50 tax imposed on sellers $9.50 $11.00 450 Whether the tax is charged to the producers or to the sellers is irrelevant the tax incidence is the same in both cases 500 450 PS= $10 $9.50 $11.00

A tax creates a wedge P between what goes out of the pocket of the buyers, in addition to what goes into the pocket of the sellers. The wedge is the tax that goes to the government. Amount Buyers pay = PB Q0 Q` Amount Sellers receive = PS Total Tax (wedge) $1.50 Quiz: In the graph below, the after-tax price paid by buyers in addition to price received by sellers are, respectively, Price received by sellers Price paid by buyers $4.00 $6.00 $5.00 $6.00 $6.00 $5.00 $6.00 $4.00 P PS 3.Who pays the tax burden If Supply is more inelastic, the larger share of the burden falls on the sellers. If Dem in addition to is more inelastic, the larger share of the burden falls on the buyers P Q0 What matters is the elasticity of Supply in addition to Dem in addition to ~ those that are more flexible (adaptive) pay less, those that are less flexible pay more ~ Q1 Q0 Q1 PS PB

Quiz: Suppose the government enacts a tax as shown in the diagram below. The policy will cause the equilibrium price to rise by $2. buyers to bear a higher burden of the tax than sellers. buyers in addition to sellers to each bear a $1 burden of the tax. quantity to fall by 4 units. 3. Willingness to Pay in addition to Consumer Surplus Welfare Economics Recall, the allocation of resources refers to: how much of each good is produced which producers produce it which consumers consume it Welfare economics studies how the allocation of resources affects economic well-being. First, we look at the well-being of consumers.

Willingness to Pay (WTP) A buyer’s willingness to pay as long as a good is the maximum amount the buyer will pay as long as that good. WTP measures how much the buyer values the good. Example: 4 buyers’ WTP as long as an iPod WTP in addition to the Dem in addition to Curve Q: If price of iPod is $200, who will buy an iPod, in addition to what is quantity dem in addition to ed A: Anthony & Flea will buy an iPod, Chad & John will not. Hence, Qd = 2 when P = $200. WTP in addition to the Dem in addition to Curve Derive the dem in addition to schedule: 4 John, Chad, Anthony, Flea 0 – 125 3 Chad, Anthony, Flea 126 – 175 2 Anthony, Flea 176 – 250 1 Flea 251 – 300 0 nobody $301 & up Qd who buys P (price of iPod)

WTP in addition to the Dem in addition to Curve P Q About the Staircase Shape This D curve looks like a staircase with 4 steps – one per buyer. P Q If there were a huge of buyers, as in a competitive market, there would be a huge of very tiny steps, in addition to it would look more like a smooth curve. WTP in addition to the Dem in addition to Curve At any Q, the height of the D curve is the WTP of the marginal buyer, the buyer who would leave the market if P were any higher. P Q

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Consumer Surplus (CS) Consumer surplus is the amount a buyer is willing to pay minus the amount the buyer actually pays: CS = WTP – P Suppose P = $260. Flea’s CS = $300 – 260 = $40. The others get no CS because they do not buy an iPod at this price. Total CS = $40. CS in addition to the Dem in addition to Curve P Q P = $260 Flea’s CS = $300 – 260 = $40 Total CS = $40 CS in addition to the Dem in addition to Curve P Q Instead, suppose P = $220 Flea’s CS = $300 – 220 = $80 Anthony’s CS = $250 – 220 = $30 Total CS = $110

4. Costs in addition to Producer Surplus Cost in addition to the Supply Curve A seller will produce in addition to sell the good/service only if the price exceeds his or her cost. Hence, cost is a measure of willingness to sell. Cost is the value of everything a seller must give up to produce a good (i.e., opportunity cost). Includes cost of all resources used to produce good, including value of the seller’s time. Example: Costs of 3 sellers in the lawn-cutting business. Cost in addition to the Supply Curve 3 35 & up 2 20 – 34 1 10 – 19 0 $0 – 9 Qs P Derive the supply schedule from the cost data:

Producer Surplus in addition to the S Curve P Q PS = P – cost Suppose P = $25. Jack’s PS = $15 Janet’s PS = $5 Chrissy’s PS = $0 Total PS = $20 Total PS equals the area above the supply curve under the price, from 0 to Q. PS with Lots of Sellers & a Smooth S Curve The supply of shoes Suppose P = $40. At Q = 15(thous in addition to ), the marginal seller’s cost is $30, in addition to her producer surplus is $10.

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