1. Government Policy & Economic Welfare Summary of All Policies

2. 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

3. Key Assumptions No Market Failure Evaluate Market Efficiency
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

4. 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

5. 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

6. Effect of a Tax on the Supply Curve

7. Deadweight Loss

8. 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

9. 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

10. 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 and supply curves are known

11. 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

12. Evaluating The Impact Costs: Benefits Will Benefits > Tax?
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

13. 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

14. 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
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?

15. 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 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?

16. 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.

17. 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

18. An Economist’s Perspective
Cato Institute
The federal government has subsidized and regulated the dairy industry since the 1930s. A system of “marketing order” regulations was enacted in A dairy price support program was added in 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.

19. 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

20. Welfare Effects of Rationing

21. 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

22. 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 first-served 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.

23. 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

24. 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?

25. 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?