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40
4.0
3.5
3.0
2.5
2.0
1.5
1.0
05
0.5
Pizzas
40
4.0
3.5
3.0
2.5
2.0
1.5
The price
1.0
05
0.5
Pizzas
Nick spends
p
$10,, and together
g
they
y spend
p
$40 on pizza.
p
C
Conclusions
l i
Markets can under-produce
p
or over-produce
p
What can the government do to ensure that optimal
production takes place
When there is a good externality, the government
can use subsidy to increase production
When there is a bad externality
externality, the government
can use tax to reduce production
In other words, we impose tax for raising revenue.
But tax can also correct market distortion.
CHAPTER
Government Action in
Markets
quantity of housing
demanded exceeds the
quantity supplied.
There is a shortage of
housing.
housing
Because the legal price
cannot eliminate the
shortage, other
mechanisms operate:
Search activity
Black markets
With a housing
g shortage,
g ,
people are willing to pay
up to $1,200 a month.
When
Wh a price
i iis regulated
l t d and
d there
th
is
i a shortage,
h t
H
Housing
i Markets
M k t and
dR
Rentt C
Ceilings
ili
Inefficiency of Rent Ceilings
H
Housing
i Markets
M k t and
dR
Rentt C
Ceilings
ili
Are Rent Ceilings Fair?
H
Housing
i Markets
M k t and
dR
Rentt C
Ceilings
ili
A lottery
yg
gives scarce housing
g to the lucky.
y
A queue gives scarce housing to those who have
the greatest foresight and get their names on the
li t first.
list
fi t
Discrimination gives scarce housing to friends,
family members, or those of the selected race or
sex.
None of these methods leads to a fair outcome.
Th L
The
Labor
b Market
M k t and
d Minimum
Mi i
Wage
W
New labor-saving
g technologies
g
become available
every year, which mainly replace low-skilled labor.
Does the persistent decrease in the demand for
l
low-skilled
kill d labor
l b depress
d
the
th wage rates
t off these
th
workers?
L
Long
Term
T
Solution
S l ti
Attract foreign investment
Encourage local investment
Provide people with training; as more people
receive training, the supply curve of
unskilled workers shifts upwards
p
And the wage rate is back to $5 per hour
e labour
abou market
a et can
ca be efficient
e ce ta
also
so
The
But wrong policy can lead to market
distortion
Minimum Wage
A Minimum Wage
Th L
The
Labor
b Market
M k t and
d Minimum
Mi i
Wage
W
Inefficiency of a Minimum Wage
Th L
The
Labor
b Market
M k t and
d Minimum
Mi i
Wage
W
Is the Minimum Wage Fair?
Conclusions
Taxes
Who really
yp
pays
y the taxes?
Income tax is deducted from your pay and GST is
added to the price of the things you buy, so isnt it
obvious
b i
that
th t you pay these
th
taxes?
t
?
Youre going to discover that it isnt obvious who
pays a tax and that lawmakers dont
don t decide who
will pay!
Taxes
Taxes:
Same outcome whether tax on buyers
or sellers
Buyers pay $1
$1.00
00 of the tax
tax.
Sellers pay the other 50 of the tax.
Tax incidence is the same regardless of
whether the law says sellers pay or buyers
pay.
We can analyse tax using either the demand
curve or the supply curve but not both
Taxes
Tax Division and the Elasticity of Demand
The division
Th
di i i off the
th tax
t between
b t
the
th buyer
b
and
d the
th
seller depends on the elasticities of demand and
supply.
To see how, we look at two extreme cases.
Perfectly inelastic demand: buyers pay the
entire
ti tax.
t
Perfectly elastic demand: sellers pay the entire
tax.
The more inelastic the demand, the larger is
the buyers share of the tax.
Taxes
Taxes
Taxes
Tax Division and Elasticity of Supply
Taxes
Taxes
From A to
F
t B
CB is the tax
Taxes
Taxes in Practice
Taxes
Taxes and Efficiency
C
A
B
S b idi and
Subsidies
d Quotas
Q t
Because demand
for wheat is
inelastic, total
revenue
increasesto $90
billion.
Because demand
for wheat is
inelastic, total
revenue
decreasesto
$50 billion.
S b idi and
Subsidies
d Quotas
Q t
Subsidies: From A to B
C
A
B
Production Quotas
Limit production to 40: A to B
No quota: Price = $30/ton; 60
million tons a y
year p
produced.
Production quota of 40
million tons a year: market
price rises to $50/ton and
marginal cost falls to $20/ton
H
Hence
quotas
t higher
hi h price
i
Consumers lose
Producers
P d
gain
i
Social cost = area ABC
A
C
THE END