1. Notes 4.4: Taxes and Subsidies
4 Different Types of Government Intervention: and their effects on… P, Qs, Qd, CS, PS, DWL

2. Government Involvement
#1 - Price Controls: Floors and Ceilings #2 - Taxes #3 - Subsidies #4 – Tariffs and International Trade

3. #1 - PRICE CONTROLS
Who likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon?

4. To have an effect, a price ceiling must be BELOW equilibrium
Maximum legal price a seller can charge for a product.
Goal: Make affordable by keeping price from reaching Eq.
To have an effect,
a price ceiling must be
BELOW equilibrium P
Gasoline S $5 4 3 2 1
Does this policy help consumers?
Result: BLACK MARKETS
Price Ceiling
Shortage
(Qd>Qs) D o Q 4

5. To have an effect, a price floor must be ABOVE equilibrium
Minimum legal price a seller can sell a product.
Goal: Keep price high by keeping price from falling to Eq.
To have an effect,
a price floor must be
ABOVE equilibrium P
Corn S $ 4 3 2 1
Surplus
(Qs>Qd)
Price Floor
Does this policy help corn producers? D o Q 5

6. Practice Questions
1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium?
Surpluses will develop
Shortages will develop
Underground markets will develop
The equilibrium price will remain the same
The quantity sold will increase
2. Which of the following statements about price control is true?
A. A price ceiling causes a shortage if the ceiling price is above the equilibrium price
B. A price floor causes a surplus if the price floor is below the equilibrium price
C. Effective price ceilings and price floors result in an inefficient allocation of resources
D. Price floors above equilibrium cause a shortage
Answers: D C

7. Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and producers surplus P S CS P1 PS D Qe Q

8. Are Price Controls Good or Bad? DEADWEIGHT LOSS The Lost CS and PS.
To be “efficient” a market must maximize consumers and producers surplus P S CS
Price FLOOR
DEADWEIGHT LOSS The Lost CS and PS.
INEFFICIENT! P1 PS D
Qfloor Qe Q

9. Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and producers surplus P S CS P1 PS D Qe Q

10. Are Price Controls Good or Bad? DEADWEIGHT LOSS The Lost CS and PS.
To be “efficient” a market must maximize consumers and producers surplus P S
DEADWEIGHT LOSS The Lost CS and PS.
INEFFICIENT! CS P1
Price CEILING PS D
Qceiling Qe Q

11. #2 Taxes Two types of Taxes: LUMP SUM Tax
Any tax charged once, regardless of how many are produced or sold
This is a Fixed Cost… so it affects ONLY AFC and ATC.
PER UNIT Tax (aka Excise Tax)
Any tax that is charged for each unit produced or sold.
This is a Variable cost… so it affects AVC, ATC, and MC … but not AFC 11

12. Definition: A per unit tax on producers
Excise Tax
Definition: A per unit tax on producers
For every unit made, the producer must pay $___
NOT a Lump Sum (one time only)Tax
The goal is often for them to make less of the goods that the government deems dangerous or unwanted.
Ex:
Cigarettes “sin tax”
Alcohol “sin tax”
Tariffs on imported goods
Environmentally Unsafe Products
Etc. 12

13. Government sets a $2 per unit tax on Cigarettes
Supply Schedule
Government sets a $2 per unit tax on Cigarettes P P Qs $5
140 $4
120 $3
100 $2 80 $1 60 S $5 4 3 2 1 D o Q 13

14. Government sets a $2 per unit tax on Cigarettes
Supply Schedule
Government sets a $2 per unit tax on Cigarettes P P Qs
$5 $7
140
$4 $6
120
$3 $5
100
$2 $4 80
$1 $3 60 S $5 4 3 2 1 D o Q 14

15. Tax is the vertical distance between supply curves
Per Unit Tax
S + Tax
Supply Schedule P P Qs
$5 $7
140
$4 $6
120
$3 $5
100
$2 $4 80
$1 $3 60 S $5 4 3 2 1
Tax is the vertical distance between supply curves D o Q 15

16. Identify the following:
Per Unit Tax
S + Tax
Identify the following:
Price before tax
Price consumers pay after tax
Price producers get after tax
Total tax revenue for the government before tax
Total tax revenue for the government after tax P S $5 4 3 2 1
1.$3
2.$4
3.$2
4.$0
5.$160 D o Q 16

17. Per Unit Tax
S + Tax 17

18. S + Tax
Per Unit Tax 18

19. Per Unit Tax 19

20. BEFORE the Tax S2
Market Price S1 D1 20

21. 21

22. Tax Practice CS Before Tax PS Before Tax CS After Tax PS After Tax
Tax Revenue for Government
Dead Weight Loss due to tax
Amount of tax revenue producers pay
1.ABCD
2.HFEG
3.A
4.G
5.BCHF
6.DE
7.HF 22

23. Excise Tax P
$14 12 11 8 S D 10 12 Q

24. Excise Tax 12 P Stax S $14 11 Pc 8 Pp D 12 10 Q Calculate Tax Per Unit
Total Tax Revenue
Amount of Tax paid by consumers
Amount of Tax paid by producers
Total Cost paid by buyers
Total Revenue for firms P
Stax
$14 12 11 8 S Pc Pp
$3 per unit
$30
$20
$10
14x10 = $140
11x10 = $110 D 10 12 Q

25. Excise Tax Calculate CS Before Tax Total paid by Buyers Before Tax
Tax Per Unit
Total Tax Revenue that goes to Government
Amount of Tax paid by consumers
Amount of Tax paid by producers
Total paid by Buyers after tax
Total Revenue for firms after tax
CS After Tax
DWL
$135
$450
$2 per unit
$120
$60
$360
$240
$30

26. Elasticity and Excise Taxes Who ends up paying for an excise tax?26

27. EXCISE TAX ON CIGARETTESP
Demand- Inelastic
Supply- Unitary
$10 8 6 5 4 2 S CS
$2 TAX on Producers D 8 10 Q 27

28. EXCISE TAX ON CIGARETTESP S1
$10 8 7 6 5 4 2 S
CS After
$6.50 =Pconsumers
Amount Consumers Pay
$2 TAX on Producers
$4.50 = Pproducers
Amount Producers Pay D 9 10 Q
Quantity Doesn’t Fall VERY Much!!! 28

29. EXCISE TAX ON YACHTS $2 TAX on Producers 5 P $10 8 6 4 2 S D 8 10 Q
Demand- Elastic
Supply- Unitary
$10 8 6 5 4 2 S
$2 TAX on Producers D 8 10 Q 29

30. EXCISE TAX ON YACHTS $2 TAX on Producers 5 P S1 $10 8 S 6 4 2 Pc Pp D
DWL? Pp D 7 10 Q
Quantity Falls A lot!!! 30

31. EXCISE TAX ON CIGARETTESP S1
$10 8 7 6 5 4 2 S
CS After
Pconsumers = $7
Tax per Unit?
Total Tax Revenue?
Tax paid by consumers?
Tax paid by producers?
Total spending?
Revenue for businesses?
Pproducers = $4 D 20 30 Q 31

32. EXCISE TAX ON CIGARETTESP S1
$10 8 7 6 5 4 2 S
CS After
Pconsumers = $7
Tax per Unit = $3
Total Tax Revenue = $60
Tax Paid by Consumers = $40
Tax Paid by Producers = $20
Total Spending = $140
Revenue for Businesses=$80
Pproducers = $4 D 20 30 Q 32

33. #3 Subsidies The government just gives producers money.
The goal is for them to make more of the goods that the government thinks are important.
Ex:
Agriculture (to prevent famine)
Pharmaceutical Companies
Environmentally Safe Vehicles
FAFSA

34. Result of Subsidies to Corn Producers
Price of Corn S
S - Subsidy P1
Subsidy is the vertical distance between supply curves P2 D o Q1 Q2 Q
Quantity of Corn 34

35. Result of Subsidies to Corn Producers
Price of Corn S
S - Subsidy
Price Down
Quantity Up
Everyone Wins, Right? P1 P2 D o Q1 Q2 Q
Quantity of Corn 35

36. Subsidies

38. #4 Tariffs A quota is a limit on number of imports.
The government sets the maximum amount that can come in the country.
Purpose:
To protect domestic producers from a cheaper world price.
To prevent domestic unemployment

39. International Trade and Quotas
Identify the following:
CS with no trade
PS with no trade
CS if we trade at world price (PW)
PS if we trade at world price (PW)
Amount we import at world price (PW)
If the government sets a quota on imports of Q4 - Q2, what happens to CS and PS?
1.H
2.TLI
3.HIJKLMNRS
4.T
5.Q5-Q1
6. CS gets smaller and PS gets bigger
This graphs show the domestic supply and demand for grain. The letters represent area.

40. Use Reffonomics mini-lesson to examine the Tariff Graph
1.H
2.TLI
3.HIJKLMNRS
4.T
5.Q5-Q1
6. CS gets smaller and PS gets bigger

41. 1.H
2.TLI
3.HIJKLMNRS
4.T
5.Q5-Q1
6. CS gets smaller and PS gets bigger

42. 1.H
2.TLI
3.HIJKLMNRS
4.T
5.Q5-Q1
6. CS gets smaller and PS gets bigger