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Econ 201 Government Policy & Economic Welfare Summary of All Policies Econ 201 Government Policy & Economic Welfare Summary of All Policies

Evaluating the Impact of Government Intervention • Policy Instruments Available – Taxes • Typically: Evaluating the Impact of Government Intervention • Policy Instruments Available – Taxes • Typically: per-unit tax on output • Others: lump-sum, value added (VAT) – Subsidies • Rebate on per-unit produced – Price Floors • Minimum price that can be charged (e. g. , minimum wage) – Price Ceilings • Limit on the maximum price that can be charged (WIN) – Quotas • Limits on amounts produced/imported • Infant industry/protectionism

Key Assumptions • No Market Failure – No externalities • i. e. , benefits Key Assumptions • No Market Failure – No externalities • i. e. , benefits or costs that are not accounted for in the marketplace (e. g. , no free riders, no pollution costs that aren’t captured in the product’s price) – Perfectly competitive markets • Large # of suppliers and buyers • Evaluate Market Efficiency – Look at losses/gains in consumer/producer surplus

Effect of a Tax on the Supply Curve • To the supplier: increases per-unit Effect of a Tax on the Supply Curve • To the supplier: increases per-unit costs – Shifts supply curve to the left • Reduces amount supplied and raises the market clearing price • How do we measure the effects of the tax? – Efficiency or deadweight losses are losses in consumer and producer surplus relative to the “ideal” market

How Do We Analyze the Effects of Taxes and Subsidies • The efficient ideal How Do We Analyze the Effects of Taxes and Subsidies • The efficient ideal market – “perfectly competitive” market • Consumers and suppliers are price-takers, i. e. have no market power

Effect of a Tax on the Supply Curve Effect of a Tax on the Supply Curve

Deadweight Loss Deadweight Loss

How Do We Evaluate the Impact of the Tax? • Two Parts: – Tax How Do We Evaluate the Impact of the Tax? • Two Parts: – Tax Incidence • Who pays for it more? – Consumers or Producers? – Will depend on relative demand/supply elasticities – Economic welfare analysis • Does the tax (revenue) improve social welfare? – Will depend on relative elasticities of: » a) good taxed » B) good or program financed by the tax

Tax Incidence • Essential question is: how much of the tax can be passed Tax Incidence • Essential question is: how much of the tax can be passed on to consumers? – Suppliers will be able to a higher proportion of the tax onto consumers when • Demand is relatively inelastic • Supply is relatively elastic – Under these conditions • Consumer surplus losses >> producer surplus losses

Economic Welfare Analysis • Framework for analysis is comparing benefits and costs – Costs Economic Welfare Analysis • Framework for analysis is comparing benefits and costs – Costs of the tax • Reduction in equilibrium quantity • Increase in price paid – Costs can be calculated as the deadweight loss in $ if demand supply curves are known

What Are the Benefits? • Depends on what we do with the tax revenues What Are the Benefits? • Depends on what we do with the tax revenues • Suppose we use it to subsidize another good • Subsidy appears as a reduction in per-unit costs to the firm getting the subsidy

Evaluating The Impact • Costs: – Deadweight loss: sum of reduction in consumer and Evaluating The Impact • Costs: – Deadweight loss: sum of reduction in consumer and producer surplus for the taxed good • Reflects reduction in Qd and higher price paid • Benefits – Gain in CS and PS from subsidized cost • Will Benefits > Tax? – Depends on the relative demand elasticities for the 2 goods

Evaluating the Impact • “A Positive Analysis” (Distributional Consequences) – Who gains/loses from the Evaluating the Impact • “A Positive Analysis” (Distributional Consequences) – Who gains/loses from the tax and subsidy? – Both producers and consumers of the taxed good lose (in terms of lost surpluses) – Relative demand/elasticities determine who loses more » More inelastic demand -> greater is CS loss – Producers and Consumers of subsidized good win (lower price and more Q) – Relative demand supply elasticities determine who benefits most

Total Social Welfare • Ideally the impact of a program should be evaluated as: Total Social Welfare • Ideally the impact of a program should be evaluated as: {Pareto efficient} – – – • 1) can at least one person’s welfare be improved 2) without making anyone worse off http: //en. wikipedia. org/wiki/Pareto_efficiency More realistically: Could the winners compensate the losers? {Pigouvian} – – Is the deadweight loss of the taxed good less than the surplus gain from the subsidized good? http: //en. wikipedia. org/wiki/Pigovian_tax

So Do They Do This in the Real World? • The Senate has approved So Do They Do This in the Real World? • The Senate has approved a bill that would require gasoline producers to blend 36 billion gallons of ethanol into gasoline by 2022, an increase from the current standard of 7. 5 billion gallons by 2012. The House did not include such a provision in the version it passed, and it is uncertain whether any final legislation will emerge this year and what it will say about ethanol if it does. • What would be the impact of such legislation on the demand for ethanol? For corn-based food prices?

Price Floors • A price floor is a government or group imposed limit on Price Floors • A price floor is a government or group imposed limit on how low a price can be charged for a product. – For a price floor to be effective, it must be greater than the equilibrium price.

Examples of Price Floors • Minimum wage – Can create a surplus of labor Examples of Price Floors • Minimum wage – Can create a surplus of labor • Agricultural price supports – Every year, farmers produce and sell a certain product at a certain price that is determined by the market. If the market price is lower than that price at which the farmers want to sell, the farmers are in a deficit. Therefore, in order to assist American farmers, our government gives price supports for some crops and dairy products. So in a case where the market price is lower that the target price for farmers, farmers receive a "deficiency payment", or price support, from the government in order to make up for the difference. – Has created a surplus of cheese and milk products • Some released to low-income/poverty households • Can exacerbate the effect by increasing supply

An Economist’s Perspective • Cato Institute – http: //www. cato. org/pubs/tbb_0707_47. pdf • The An Economist’s Perspective • Cato Institute – http: //www. cato. org/pubs/tbb_0707_47. pdf • The federal government has subsidized and regulated the dairy industry since the 1930 s. A system of “marketing order” regulations was enacted in 1937. A dairy price support program was added in 1949. An income support program for dairy farmers was added in 2002. • As part of this year’s farm bill, Congress may reauthorize dairy programs, but they are among the most illogical of all farm programs. 1 The government spends billions of dollars reducing food costs through programs such as food stamps, yet dairy programs increase milk prices.

Price Ceilings • A price ceiling is a government-imposed limit on how high a Price Ceilings • A price ceiling is a government-imposed limit on how high a price can be charged on a product. For a price ceiling to be effective, it must differ from the free market price – Example: • New York City rent control – Landlords are not allowed to raise rental prices • Gerald Ford’s Whip Inflation Now (WIN) • World War II – Somewhat effective (resulted in blackmarkets, rationing) – Impact: • Shortages and higher costs

Welfare Effects of Rationing Welfare Effects of Rationing

Quotas • A restriction of limit on: – The number of migrant workers that Quotas • A restriction of limit on: – The number of migrant workers that can be legally employed in the US – The amount of a good or resource that can be imported to the US, or exported from the US – The amount of a resource that can be “harvested” during a period of time (e. g. , fish or mining) – The amount of a pollutant that can be emitted – The number of taxi cabs that can be licensed

Trade Quotas • • • Import quotas are limitations on the quantity of goods Trade Quotas • • • Import quotas are limitations on the quantity of goods that can be imported into the country during a specified period of time. An import quota is typically set below the free trade level of imports. In this case it is called a binding quota. If a quota is set at or above the free trade level of imports then it is referred to as a non-binding quota. Goods that are illegal within a country effectively have a quota set equal to zero. Thus many countries have a zero quota on narcotics and other illicit drugs. There are two basic types of quotas: absolute quotas and tariff-rate quotas. Absolute quotas limit the quantity of imports to a specified level during a specified period of time. Sometimes these quotas are set globally and thus affect all imports while sometimes they are set only against specified countries. Absolute quotas are generally administered on a first-come firstserved basis. For this reason, many quotas are filled shortly after the opening of the quota period. Tariff-rate quotas allow a specified quantity of goods to be imported at a reduced tariff rate during the specified quota period. In the US in 1996, milk, cream, brooms, ethyl alcohol, anchovies, tuna, olives and durum wheat were subject to tariff-rate quotas. Other quotas exist on peanuts, cotton, sugar and syrup.

Useful Websites • http: //www. sjsu. edu/faculty/watkins/taximpact. html • • • Economic Welfare Analysis Useful Websites • http: //www. sjsu. edu/faculty/watkins/taximpact. html • • • Economic Welfare Analysis Price Controls Monopoly Monopsony Taxes and Subsidies Oligopoly Marginal Cost Pricing Price Discrimination Trade Externality Tax

Weekend’s Problem • # 1: Congress is currently considering an energy bill which would Weekend’s Problem • # 1: Congress is currently considering an energy bill which would mandate that all gasoline producers use include at least 10% ethanol in each gallon of gas – 1. What would be the impact of this on the gasoline market? – 2. What would be the impact of this on the ethanol market? – 3. Impact on the corn market (for both food and gasoline)? – 4. Impact on the food products containing corn market?

Weekend’s Problem • #2 The US provides price supports (minimum price) to the producers Weekend’s Problem • #2 The US provides price supports (minimum price) to the producers of milk. – Assuming that the support is effective, what would be the economic welfare impact on the milk market? – The US government also provides food stamps to subsidize food purchases. What is the impact of the food stamp program (alone) on economic welfare? – What can you say about the combined impact of both the price support and food stamp programs on economic welfare?