Economics & Finance

The Economics of Taxation Causes of Increased Inequality Marginal versus Average Tax Rates TABLE 19.3 Individual Income Tax Rates, 2007 Married Couples Filing Jointly Taxable IncomeTax Rate $0 – 15,65010% $15,651 – 63,70015% $63,701 – 128,50025% $128,501 – 195,85028% $195,851 – 349,70033% More than $349,70035% Single Taxpayers Taxable IncomeTax Rate $0 – 7,82510% $7,826 – 31,85015% $31,851 – 77,10025% $77,101 – 160,85028% $160,851 – 349,70033% More than $349,70035% Source: The Internal Revenue Service.

The Economics of Taxation Causes of Increased Inequality Marginal versus Average Tax Rates TABLE 19.4 Tax Calculations for a Single Taxpayer Who Earned $100,000 in 2007 Total income$ 100,000  Personal exemption 3,400  Standard deduction 5,350 = Taxable income$ 91,250 Tax Calculation 0 - $7,825 taxed at 10% = $7,825 X.10 =$ $7,825 - $31,850 taxed at 15% ($31,850 – $7,825) X.15 = $24,025 X.15 =$ 3, $31,850 - $77,100 taxed at 25% = ($77,100 – $31,850) X.25 = $45,250 X.25 =$11, Income above $77,100 taxed at 28% = ($91,250 - $77,100) X.28 = $14,150 X.28 =$ 3,962 Total tax$19, Average tax rate19.7% Marginal tax rate28%

Government Policies That Alter the Private Market Outcome Price Controls – Price Ceiling: a legal maximum on the price of a good or service. Example: rent control. – Price Floor: a legal minimum on the price of a good or service. Example: minimum wage. Taxes – The Government can make buyers or sellers pay a specific amount on each unit bought/sold.

Price Floors When the government imposes a price floor, two outcomes are possible. uThe price floor is not binding if set below the equilibrium price. uThe price floor is binding if set above the equilibrium price, leading to a surplus.

A Price Floor That Is Not Binding... $3 Quantity of Shave-Ice Cones 0 Price of Shave-Ice Cone 100 Equilibrium quantity Equilibrium price Demand Supply Price floor 2

A Price Floor That Is Binding... $3 Quantity of #2 Wheat 0 Price of #2 Wheat Equilibrium price Demand Supply Price floor$4 120 Quantity supplied 80 Quantity demanded Surplus Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Effects of a Price Floor A price floor prevents supply and demand from moving toward the equilibrium price and quantity. When the market price hits the floor, it can fall no further, and the market price equals the floor price.

Effects of a Price Floor A binding price floor causes...  a surplus because Q S >Q D.  nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. uExamples: The minimum wage, Agricultural price supports

The Market for Apartments Equilibrium without price controls P Q D S Rental price of apartments $ Quantity of apartments

How Price Ceilings Affect Market Outcomes A price ceiling above the equilibrium price is not binding – has no effect on the market outcome. P Q D S $ Price Ceiling $1000

How Price Ceilings Affect Market Outcomes The equilibrium price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constraint on the price, causes a shortage. P Q D S $800 Price Ceiling $ Shortage

The Minimum Wage An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.

The Minimum Wage Quantity of Labor 0 Wage Equilibrium wage Labor demand Labor supply A Free Labor Market Equilibrium employment

Minimum wage The Minimum Wage Quantity of Labor 0 Wage Labor demand Labor supply Quantity supplied Quantity demanded Labor surplus (unemployment) A Labor Market with a Minimum Wage

Effects of Minimum Wage Less likelihood of health insurance Less training More discrimination in hiring

Evaluating Price Controls Markets are usually a good way to organize economic activity.  Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices.  Price controls often intended to help the poor, but often hurt more than help.