1. Long Run and Short Run Issues :The Role of Policy In the long run all issues are changeable but in the short run some elements are fixed. The process of adjustment is the target for government policies to influence outcomes that improve welfare. The devices that governments use vary but basically deal with either prices through regulation or taxation or quantity through supply management techniques such as quotas or prescriptions. The policy role that governments use depends on various pressures not all of which come from the marketplace. Political, social, foreign and financial pressure can also alter government policy.

2. Techniques of Policy Governments may use: -regulation through contraband (Alcohol,Tobacco) or market entry barriers (FIRA)or quotas -taxation (direct [GST] or indirect [Income Tax]) -subsidies through grants [ WEDC, ALCOA, etc.] -prescriptions by setting minimum standards including pricing, registration and performance standards (labeling, etc.) In all cases there is a either a short or long run risk of creating a deadweight welfare loss that affects all of society.

3. Contraband and Market Entry Barriers Contraband means that a good or service is illegal and is often set in place by international agreement. It is generally defined as one in which the Cost of supply is set so high that it eliminates the market completely. Market entry barriers are set so that suppliers must pay a very high market entry price and in the process transfers most of the business surplus to suppliers and also may eliminate the market completely.

4. Contraband Penalty level must be set at 0:Pme to eliminate the market. Price Quantity Supply Demand Pme 0

5. Market Entry Barriers Market Entry Barriers must be set so that producers must incur costs [0:Pmeb] so that they can only enter the market after the saturation point. Sometimes these include investing in other markets. Demand Supply Price Quantity Saturation Point 0 Pmeb

6. Adjustments to Contraband and Market Entry Barriers In the long run supply may or may not adjust: - for contraband by shifting to the black market and carrying on business illegally. - for market entry barriers by market abandonment (leaving), creating local subsidiaries that diversify (manipulating transfer pricing regimes), or by political influence (bribery).

7. Direct and Indirect Taxation Direct Taxation affects a particular good or transaction and may be considered as an increase in costs if the producer pays and an decrease in income if the consumer pays it. Indirect taxation markets relates to general taxation and may be applied to either producers or consumers or both. Note: this relates to the market perspective and is the mirror image of the common political interpretation of direct taxation (income tax) and indirect taxation (GST).

8. Direct Taxation on Consumers (1) A tax on buyers shifts the demand curve downward by the level of the tax and its metric. (flat or proportional) Price Buyers Pay Price Without Tax Price Sellers Receive Equilibrium Quantity Quantity Sellers Offer Quantity Price A FLAT TAX ON CONSUMERS REDUCES QUANTITY. TAX

9. Direct Taxation on Consumers (2) A tax on buyers shifts the demand curve downward by the level of the tax and its metric. (flat or proportional) Price Without Tax Equilibrium Quantity Quantity Price A PROPORTIONAL INCREASING TAX ON CONSUMERS DEMAND 1 TO DEMAND 2 REDUCES QUANTITY Price Sellers Receive Price Buyers Pay Quantity Sellers Offer Tax rate increases as quantity increases Demand 1 Demand 2 TAX

10. Direct Taxation on Consumers (3) A tax on buyers shifts the demand curve downward by the level of the tax and its metric. (flat or proportional) Price Without Tax Equilibrium Quantity Quantity Sellers Offer (1) Quantity Price Tax rate decreases as quantity increases Demand 2 Demand 1 A PROPORTIONAL DECREASING TAX (SUBSIDY) ON CONSUMERS DEMAND 1 TO DEMAND 2 INCREASES QUANTITY Price Producers Receive Price Consumers Pay SUBSIDY

11. Indirect Taxation Indirect taxation refers to taxes placed on suppliers or others who are involved in the market. This often happens in terms of income tax credits and rely on: - confidence in the taxing government maintaining the appropriate tax regime - the value of a tax deduction or other type of credit in the future - the persistence of the technology that uses or values that product.

12. Adjustments to Direct and Indirect Taxation In the long run direct or indirect taxation will lead to markets shifting away from the product or towards the product and in the process reconfiguring the technological background against which the market functions. Often the long term adjustment removes the “perceived political” need for a market intervention before the burden of taxation or subsidy or deductions escalate.

13. Government Prescriptions Governments can use their “market control power” to set standards such as maximum pricing or quotas or pursue policies of enforcement or education. (External Factors) These prescriptions depend on the elasticity of the supply and demand as does the long term adjustment which generally goes from inelastic to elastic for supply and reverse for demand. (Internal Factors)

14. Maximum Pricing: Price Ceilings and Price Floors At A price ceiling is too high and creates a surplus, at B it is too low and creates a shortage. Supply Demand Surplus Shortage Quiantity Price A B

15. External Factors Affecting Supply Market adjustments may arise due to autonomous supply changes such as crop failures or cartels restricting market supply (Supply 2) and a surplus may become a shortage and visa versa. Supply Supply 2 Set Price Surplus Shortage Demand Short Run Long Run

16. External Factors Affecting Demand Market adjustments may arise due to autonomous demand changes such as education programs or enforcement of standards (Demand 2) and a surplus may become a shortage and visa versa. Supply Set Price Surplus Shortage Demand Demand 2 Short Run Long Run

17. Internal Factors Affecting Supply Ease of entry or exit from the industry or adjustments in “definitions” may alter the elasticity of supply and expand or contract either a surplus or a shortage. Supply Inelastic Supply elastic Demand Shortage Shortage 2 Set Price Short RunLong Run

18. Internal Factors Affecting Demand Educational initiatives and enforcement of patent law expirations can flatten demand as consumers accept the product as a necessity and hence expect competition to increase substitutes and also to stabilize prices thereby reducing demand elasticity and modifying surpluses or shortages. Supply Demand elastic Shortage Demand inelastic Short Run Long Run Set Price

19. Adjustments to Government Prescriptions In general government prescriptions set standards that can aggravate surpluses or shortages and in so doing reduce quantities or expand quantities beyond the market capacity. This results in a deadweight loss: -Resources are utilized inefficiently and some get more than they should while others get less -Government becomes involved in redistributing wealth to favored sectors that would probably not survive on their own. -Factor inputs, especially natural resources, are exploited rather than managed as part of the natural endowment of the nation.

20. Microeconomic Policy Often policies are set for one purpose but have unintended effects on many other areas. Markets will adjust without government interference but will do so in ways that may not be acceptable to governments. It is up to economists to point out diseconomies and to ensure that government responses are transparent in order to make the market work for the benefit of all.