Overview of Welfare Economics Pareto Efficiency Supply & Demand Market Equilibrium Marginal Costs & Marginal Benefits Market Failure Externalities Public Goods Common Resources

“A planner’s primary obligation is to serve the public interest.” - AICP Code of Ethics and Professional Conduct

Welfare Economics: The study of how different forms of economic activity and different methods of allocating scarce resources affect the well-being of individuals or communities Pareto Efficiency: An allocation of resources is considered Pareto efficient if no alternative allocation can make at least one person better off without making someone else worse off

Supply & Demand Marginal Cost & Marginal Benefit

Demand (Benefit to Consumers or Society) The relationship between the price of a good/service and the quantity purchased by consumers Law of Demand: All else being equal, quantity demanded decreases as price increases. (The number of people whose benefit exceeds the price decreases as price increases) (Negative relationship between price and quantity = downward slope)

Demand

Supply (Cost to Producers or Society) The relationship between the price of a good/service and the quantity that producers are willing to supply Law of Supply: All else being equal, quantity produced increases as price increases. (The number of producers whose cost is lower than the price increases as price increases) (Positive relationship between price and quantity = upward slope)

Supply

Supply and Demand

MB

Social Surplus Consumer Surplus: The difference between what consumers are willing-to-pay and what they have to pay Graphically, the area under the demand curve and above the price Producer Surplus: The difference between producers’ total revenue and marginal cost Graphically, the are above the supply curve (MC) and below the price

Consumer Surplus

Producer Surplus

Social Surplus Consumer Surplus: The difference between what consumers are willing-to-pay and what they have to pay Graphically, the area under the demand curve and above the price Producer Surplus: The difference between producers’ total revenue and marginal cost Graphically, the are above the supply curve (MC) and below the price

Social Surplus

Realities of the Market The private market only ensures efficiency under strict conditions, including:  Many buyers and sellers (no monopolies)  Identical goods and services  Perfect information  No barriers to entry  No externalities (side effects)  … Even a “perfectly competitive” private market:  cannot effectively allocate public goods or common resources  Does not address issues of distribution or equity…

“Four Vital Functions of Planning” (Klosterman, 1985) Argument for and Against Planning 1.Improves information for public and private decision making 2.Considers external effects of individual and group action 3.Promotes collective interest, esp. w/ respect to public goods 4.Considers distributional effects of market actions (equity)

Zero Economic Profit? A firm that earns zero economic profit is said to earn “normal profits” Two ways to measure profit: 1.Economic Profit = Total Rev. – (Explicit Costs + Implicit Costs) 2.Accounting Profit = Total Rev. – (Explicit Costs)  Explicit Costs include: capital, labor, etc.(actual $ payments)  Implicit Costs include: the value of resources used in production for which no monetary payments are made (opportunity costs)  e.g., implicit cost to the farmer is salary he could have made had he chosen another pursuit) A firm that just covers its operating costs and its implicit costs makes ZERO economic profit, but still makes an accounting profit

Monopolist’s Marginal Revenue

D

Market Failure Externalities: Economic side effects or “spillovers.” costs or benefits that stem from an economic activity, but that affect people other than those directly involved in a market transaction. Can be POSITIVE or NEGATIVE

Market Failure Example of negative externality Driving involves direct cost: gas, driver ’ s time … and creates indirect, or external, costs: pollution, congestion, road maintenance, etc. The individual driver does not bear the indirect costs, and does not consider them in his/her decision-making process

Market Failure Example of positive externality: A beekeeper ’ s bees create benefits that can be captured: honey, sold to customers … and external benefits that cannot be captured: bees pollinate nearby orchards The orchard farmers do not pay the beekeeper for this benefit, so the beekeeper does not consider it in his decision-making process

Figure 2 Pollution and the Social Optimum Copyright © 2004 South-Western Equilibrium Quantity of Aluminum 0 Price of Aluminum Demand (private value) Supply (private cost) Social cost Q OPTIMUM Optimum Cost of pollution Q MARKET

Figure 3 Education and the Social Optimum Copyright © 2004 South-Western Quantity of Education 0 Price of Education Demand (private value) Social value Supply (private cost) Q MARKET Q OPTIMUM

Market Failure Public Goods: Defined by non-rivalrous consumption and non-excludability  Non-rivalrous consumption: Good or service can be used by one person without detracting from the ability of other to use it  Non-excludability: Impossible or impractical to exclude some people from enjoying the benefits of a good service, even if they are unwilling to pay for it

Topics  Budgets  especially revenue sources, –Especially taxes  Guidelines for Evaluating Taxes  Equity: Progressive / Regressive Taxes  The Tax Wedge, Elasticity, and Incidence

Guidelines for Evaluating Taxes Ease of Administration Equity 1.Ability to pay (progressivity vs. regressivity) 2.Benefit principle of taxation Efficiency 1.Effect on social surplus (welfare) 2.Ability to raise revenue

Tax Equity Progressive: Burden of tax increases w/ income. Higher inc households spend a greater percentage of their income on the tax than lower income households. Regressive: Burden of tax decreases w/ income. Higher inc households spend a smaller percentage of their income on the tax than lower income households Proportionate: Burden of the tax remains the same over all levels of income

The Efficiency Effects of a Tax Copyright © 2004 South-Western Size of tax Quantity 0 Price Price buyers pay Price sellers receive Demand Supply Price without tax Quantity without tax Quantity with tax

The Effects of a Tax Levied on Sellers Copyright © 2004 South-Western (MC) Size of tax Quantity 0 Price Demand Supply P* Q* P* + t

The Effects of a Tax Levied on Sellers Copyright © 2004 South-Western Size of tax Quantity 0 Price Price buyers pay Price sellers receive Demand (MB) Supply Price without tax Quantity without tax Quantity with tax (MC)

The Effects of a Tax Levied on Buyers Copyright © 2004 South-Western Size of tax Quantity 0 Price Demand Supply P* Q* P* - t (MC)

The Effects of a Tax Levied on Buyers Copyright © 2004 South-Western Size of tax Quantity 0 Price Price buyers pay Price sellers receive Demand Supply Price without tax Quantity without tax Quantity with tax (MC) Demand (MB)

The Efficiency Effects of a Tax Copyright © 2004 South-Western Size of tax Quantity 0 Price Price buyers pay Price sellers receive Demand Supply Price without tax Quantity without tax Quantity with tax (MC)

Tax Incidence The party that actually pays the tax to the government (whether that is the seller or buyer) can pass part of that tax forward to consumer, or backward to the producer. The party that the tax is shifted to bears the tax incidence The incidence depends on price elasticity of supply and demand

Elasticity The incidence of taxation, the amount of deadweight loss caused by a tax, and the amount of revenue raised by a tax all depend on how responsive the quantity supplied and quantity demanded are to changes in price

The Efficiency Effects of a Tax Copyright © 2004 South-Western Size of tax Quantity 0 Price Price buyers pay Price sellers receive Demand Supply Price without tax Quantity without tax Quantity with tax (MC)

The Efficiency Effects of a Tax Copyright © 2004 South-Western Size of tax Quantity 0 Price Demand Supply (MC) Size of tax MC

Tax Incidence and Elasticities Copyright © 2004 South-Western Demand Supply Inelastic Demand Price 0 Quantity Size of tax Size of tax

Tax Incidence and Elasticities Copyright © 2004 South-Western Elastic Demand Price 0 Quantity Size of tax Demand Supply Size of tax

Tax Incidence and Elasticities Copyright © 2004 South-Western Inelastic Supply Price 0Quantity Demand Supply Size of tax

Tax Incidence and Elasticities Copyright © 2004 South-Western Elastic Supply Price 0 Quantity Demand Supply Size of tax

Tax Distortions and Elasticities Copyright © 2004 South-Western Demand Supply (c) Inelastic Demand Price 0 Quantity Size of tax When demand is relatively inelastic, the deadweight loss of a tax is small.

Tax Distortions and Elasticities Copyright © 2004 South-Western (d) Elastic Demand Price 0 Quantity Size of tax Demand Supply When demand is relatively elastic, the deadweight loss of a tax is large.

Tax Distortions and Elasticities Copyright © 2004 South-Western (a) Inelastic Supply Price 0Quantity Demand Supply Size of tax When supply is relatively inelastic, the deadweight loss of a tax is small.

Tax Distortions and Elasticities Copyright © 2004 South-Western (b) Elastic Supply Price 0 Quantity Demand Supply Size of tax When supply is relatively elastic, the deadweight loss of a tax is large.

Corrective Tax (negative externalities) Copyright © 2004 South-Western (Pvt MC) Size of tax Quantity 0 Price Demand (MB) Supply P* Q (Social MC) Q* P

The Effects of a Tax on Social Surplus Copyright © 2004 South-Western Quantity 0 Price Demand Supply Price without tax Quantity without tax

The Effects of a Tax on Social Surplus Copyright © 2004 South-Western Tax revenue (T × Q) Size of tax (T ) Quantity 0 Price Demand Supply Quantity without tax Quantity with tax Price buyers pay Price sellers receive

Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Demand Supply Quantity 0 Price Q1Q1 (a) Small Tax Deadweight loss PBPB Q2Q2 PSPS

Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Quantity 0 Price (b) Medium Tax PBPB Q2Q2 PSPS Supply Demand Q1Q1 Deadweight loss

Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes Copyright © 2004 South-Western Tax revenue Demand Supply Quantity 0 Price Q1Q1 (c) Large Tax PBPB Q2Q2 PSPS Deadweight loss

Sprawl Traits 1.Unlimited outward extension of development 2.Low-density residential/comm. development 3.Widespread strip commercial 4.Leapfrog development 5.Auto dependence (private auto) 6.Segregation of land uses by zones 7.Reliance on trickle down or filtering process to provide housing to low income HH 8.Lack of centralized control of land uses 9.Fragmentation of power over land use (many localities) 10.Great fiscal disparity among localities Burchell, Robert. (1998) The Costs of Sprawl – Revisited. Transportation Cooperative Research Program Report 39. Washington, DC: National Academy Press.