Chapter 6 Market Efficiency and Government Intervention

Figure 6.4 The Effect of a Per-Unit Tax on Laptop Sales

Application: Taxes and Competitive Equilibrium Three pieces of the tax increase  Incidence of a tax on consumers: Increases price that consumers pay  Incidence of a tax on producers: Decreases price producers receive  Deadweight loss: Losses in consumer and producer surplus that are not transferred to the government as revenue

Figure 6.4 The Effect of a Per-Unit Tax on Laptop Sales Deadweight Loss Incidence on consumers Incidence on producers

Elasticity and Tax Incidence Why isn’t the entire tax passed on to consumers? Incidence of a tax will be determined by the elasticities of demand and supply.

Guide to who pays more E d > E s producer bears most of the tax burden E d < E s consumer bears most of the tax burden E d = E s equally share the tax burden

Can you draw who pays more of the tax?? Perfectly inelastic demand Perfectly elastic supply Demand more elastic than supply Supply more elastic than demand

Can we do it? (number 8) Suppose the demand for laptops is a horizontal line at $1200, indicating that consumers will purchase zero units at any price above $1200. Use a graph to show the effect of a $100 per-laptop tax on producers.

Self test… Who pays more If demand is inelastic  Consumers pay more If demand is elastic  Producers pay more If supply is inelastic  Producers pay more If supply is elastic  Consumers pay more As demand or supply elasticity increases, the deadweight loss increases.

Theory in Action… money_1;_ylt=AotIC78uRu8XEm7DcrPJvKGQ1EMF Drop in Smoking Means Less Tax Revenue Applied Topics: Changes in versus changes in quantity demanded and demand, price elasticity of demand money_1;_ylt=AotIC78uRu8XEm7DcrPJvKGQ1EMF The article examines decreasing tobacco tax revenues. Questions: In the short run, does the demand for cigarettes appear to be price elastic or inelastic? Explain. The article notes that, over the long run, federal tax revenues from tobacco products have decreased and despite increases in tobacco taxes in most states, these tax revenues have either decreased or are expected to decrease at the state level. Explain, using the supply and demand model, why this is happening.

Price Floors, Price Ceilings, and Quotas Three other tools the government uses to alter market outcomes:  Price Floors  Price Ceilings  Quotas reduce efficiency in markets.

Price Floor Government mandated minimum price below which legal trades cannot be made Price floor is above equilibrium price

Impacts of Price Floors Sustained surpluses Fewer exchanges  Minimum wage and agricultural subsidies

Price Floors in Labor Markets The minimum wage results in:  Increased wages for workers who can get minimum wage jobs  A reduction in employment  A surplus of labor (unemployment)  Deadweight loss

Pros and Cons of the Minimum Wage Pro:  The minimum wage helps pull some workers out of poverty. Cons:  The minimum wage could lead to: Reduced hours for workers Poor working conditions Less worker training  It mainly effects teenagers, not families living in poverty.