Transcript 1.3 Government intervention in markets

1.3 Government intervention in
markets
1.3a Indirect taxes
• Indirect taxes are taxes that are not directly related
to income. Examples include tariffs, sales taxes, and
value-added taxes. Often these are ad valorem taxes
or assessed as a % of the sales price.
• Specific taxes are assessed as a specific flat rate tax
on a good or service. For example, a $2 per airline
ticket in the U.S. to pay for airport administrative
costs would be considered a specific tax.
Indirect taxes are often used on goods that
give negative externalities (Unit 1.4b),
reducing the quantity demanded of those
goods, and providing government with
funds to fight the external costs. Pollution,
for example, might result from the exhaust
from cars and trucks, so indirect taxes are
typical for gasoline.
Consequences of indirect taxes
• Economists usually treat indirect taxes as extra
costs, pushing supply curves up and to the
left, normally reducing quantities and raising
prices. The PED and the PES will play a large
role in determining the effects of a tax. This
shift will have three effects:
1. Incidence of tax - this explains who will actually pay
the tax. This could be either the producer or the
consumer. The more price inelastic of demand, the
more the consumer will pay. The more elastic the
good or service is, the more of the tax the producer
will pay.
2. Government revenues – how much income the
government will generate from the tax. This will
vary with the elasticity for the item being taxed.
3. Resource allocation - how the market reallocates
resources after the change in price.
What is the role of elasticity in taxes?
• Who pays the tax, how much money the
government receives and the resource
allocation are all factors, which will be
impacted by the elasticities for the good or
service being taxed.
Let’s look at a diagram:
In the scenario above, the starting equilibrium price is $3. When an in direct tax is
levied on the good in question, the supply curve will shift up to St by the amount
of the tax. The new equilibrium price will rise to just below $4.
1.3b Subsidies
• The incidence of tax will fall relatively equally on
both producers (area b) and consumers (area a) due
to the relative unit elastic PED and PES. The revenues
accruing to the government is the combined areas of
a and b. Resources will be reallocated with
quantities supplied/demanded falling from Q to Q’.
•
• Notice the two small two triangles directly below the
new equilibrium. These will combine to form a
deadweight loss of efficiency.
• This deadweight loss is due to the fact that consumers
were willing to purchase more of the good in question
yet could not due to the higher price.
• This area represents a loss in society’s net benefit due to
reducing production and consumption below free market
levels where marginal benefit is equal to marginal cost.
• Finally, remember that taxes will diminish consumer
surplus and producer surplus in varying degrees
depending upon the elasticities of the good or service
being taxed.
1.3b Subsidies
• Subsidies are payments from the government
given for the production of goods or provision
of services that are thought good for society.
This might be because of positive externalities
(such as vaccinations) or because a product
(food) is thought necessary for the well - being
of certain people. A subsidy can also be used
to even out income streams for farmers in
high income countries.
This payment can be made to either
producers or consumers or the government
can directly provide the product in question.
Economists typically analyze the effects of
subsidies as a reduction in costs, shifting
supply curves down and to the right,
lowering prices and increasing quantities
bought and sold.
• In the diagram above, the government has
subsidized a given product or service. This
pushes the supply curve to the right from S
to Ss.
• The result is a lower price for consumers at
Ps and higher consumption at Qs. The area
between the supply curves would represent
the cost to the government of providing the
subsidy to either producers or consumers.
1.3c Price controls
• Policy makers sometimes attempt to prevent
changes in price, preventing an equilibrium
price and creating an artificial shortage or
surplus.
• Setting a maximum price is called a price
ceiling, an effort to keep prices below
equilibrium.
Price ceilings create incentives for people to
resell goods on a black market, allowing real
prices to be higher anyway.
Laws that prohibit the reselling of goods can
be very difficult to enforce. Examples of price
ceilings are rent control in cities like New York.
Setting a minimum price is called a price floor,
an effort to keep prices above equilibrium,
which will usually benefit producers.
Price controls are difficult to enforce and can
be quite expensive to implement.
Price floors are usually enforced through
government purchase of surplus stocks at a
fixed price. This can be quite expensive and has
historically been a tool in supporting
agricultural prices so that farmers have
predictable incomes. Inefficiencies of price
floors can be the added cost of how the
government must dispose of the surplus
output.
Buffer stock schemes
For some products—goods that can be stored
cheaply for a long time—a buffer stock
scheme can be used to keep prices stable.
These schemes combine price floors and
price ceilings in attempting to manage prices.
Price stability is achieved by controlling the
supplies of a good on the market: increasing
supplies when prices are high, decreasing
supplies when prices are low.
Managers decrease supplies by putting them in
storage.
Buffer stock schemes are commonly seen in
agricultural markets, particularly with grains or
non-perishables like coffee, which can be stored
for a relatively long period of time.
Many developing countries have attempted to
smooth volatility in their export revenues
through these schemes.
In more developed countries, the strategic oil
reserve might considered a variation of a buffer
stock that countries use to moderate wide
swings in the price of petroleum.