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1、6GOVERNMENT ACTIONSIN MARKETS 2012 Pearson Addison-Wesley 2012 Pearson Addison-WesleyEven though house prices have fallen,some rents have risen.Can governments cap rents to help renters?Can governments make housing more affordable by raising incomes with minimum wage laws?The government taxes almost
2、 everything we buy.But who actually pays and who benefits when a tax is cut:buyers or sellers?The government limit the quantities that some farmers may produce and subsidizes other farmers.Do production limits and subsidies help to make markets efficient?2012 Pearson Addison-Wesley 2012 Pearson Addi
3、son-WesleyHousing ShortageFigure 6.1 shows the effects of a rent ceiling that is set below the equilibrium rent.The equilibrium rent is$1,000 a month.A rent ceiling is set at$800 a month.So the equilibrium rent is in the illegal region.A Housing Market with a Rent Ceiling 2012 Pearson Addison-Wesley
4、At the rent ceiling,the quantity of housing demanded exceeds the quantity supplied.There is a shortage of housing.A Housing Market with a Rent Ceiling 2012 Pearson Addison-Wesley 2012 Pearson Addison-WesleyIncreased Search ActivityThe time spent looking for someone with whom to do business is called
5、 search activity.When a price is regulated and there is a shortage,search activity increases.Search activity is costly and the opportunity cost of housing equals its rent(regulated)plus the opportunity cost of the search activity(unregulated).Because the quantity of housing is less than the quantity
6、 in an unregulated market,the opportunity cost of housing exceeds the unregulated rent.A Housing Market with a Rent Ceiling 2012 Pearson Addison-WesleyA Black MarketA black market is an illegal market that operates alongside a legal market in which a price ceiling or other restriction has been impos
7、ed.A shortage of housing creates a black market in housing.Illegal arrangements are made between renters and landlords at rents above the rent ceilingand generally above what the rent would have been in an unregulated market.A Housing Market with a Rent Ceiling 2012 Pearson Addison-Wesley 2012 Pears
8、on Addison-WesleyA rent ceiling decreases the quantity of housing supplied to less than the efficient quantity.A deadweight loss arises.Producer surplus shrinks.Consumer surplus shrinks.There is a potential loss from increased search activity.A Housing Market with a Rent Ceiling 2012 Pearson Addison
9、-WesleyAre Rent Ceilings Fair?According to the fair rules view,a rent ceiling is unfair because it blocks voluntary exchange.According to the fair results view,a rent ceiling is unfair because it does not generally benefit the poor.A rent ceiling decreases the quantity of housing and the scarce hous
10、ing is allocated by Lottery First-come,first-served DiscriminationA Housing Market with a Rent Ceiling 2012 Pearson Addison-WesleyA lottery gives scarce housing to the lucky.A first-come,first served gives scarce housing to those who have the greatest foresight and get their names on the list first.
11、Discrimination gives scarce housing to friends,family members,or those of the selected race or sex.None of these methods leads to a fair outcome.A Housing Market with a Rent Ceiling 2012 Pearson Addison-Wesley 2012 Pearson Addison-WesleyMinimum Wage Brings UnemploymentIf the minimum wage is set abov
12、e the equilibrium wage rate,the quantity of labor supplied by workers exceeds the quantity demanded by employers.There is a surplus of labor.The quantity of labor hired at the minimum wage is less than the quantity that would be hired in an unregulated labor market.Because the legal wage rate cannot
13、 eliminate the surplus,the minimum wage creates unemployment.A Labor Market with a Minimum Wage 2012 Pearson Addison-WesleyThe equilibrium wage rate is$6 an hour.The minimum wage rate is set at$7 an hour.So the equilibrium wage rate is in the illegal region.The quantity of labor employed is the quan
14、tity demanded.A Labor Market with a Minimum Wage 2012 Pearson Addison-WesleyA Labor Market with a Minimum WageThe quantity of labor supplied exceeds the quantity demanded and unemployment is created.With only 20 million hours demanded,some workers are willing to supply the last hour demanded for$8.2
15、012 Pearson Addison-WesleyInefficiency of a Minimum WageA minimum wage leads to an inefficient outcome.The quantity of labor employed is less than the efficient quantity.The supply of labor measures the marginal social cost of labor to workers(leisure forgone).The demand for labor measures the margi
16、nal social benefit from labor(value of goods produced).Figure 6.4 illustrates this inefficient outcome.A Labor Market with a Minimum Wage 2012 Pearson Addison-Wesley 2012 Pearson Addison-WesleyIs the Minimum Wage Fair?A minimum wage rate in the United States is set by the federal governments Fair La
17、bor Standards Act.In 2009,the federal minimum wage rate was$7.25 an hour.Some state governments have set minimum wages above the federal minimum wage rate.Most economists believe that minimum wage laws increase the unemployment rate of low-skilled younger workers.A Labor Market with a Minimum Wage 2
18、012 Pearson Addison-WesleyTaxesEverything you earn and most things you buy are taxed.Who really pays these taxes?Income tax and the Social Security tax are deducted from your pay,and state sales tax is added to the price of the things you buy,so isnt it obvious that you pay these taxes?Isnt it equal
19、ly obvious that your employer pays the employers contribution to the Social Security tax?Youre going to discover that it isnt obvious who pays a tax and that lawmakers dont decide who will pay!2012 Pearson Addison-Wesley 2012 Pearson Addison-WesleyTax incidence doesnt depend on tax law!The law might
20、 impose a tax on buyers or sellers,but the outcome will be the same.To see why,we look at the tax on cigarettes in New York City.On July 1,2002,New York City raised the tax on the sales of cigarettes from almost nothing to$1.50 a pack.What are the effects of this tax?Taxes 2012 Pearson Addison-Wesle
21、yA Tax on SellersFigure 6.5 shows the effects of this tax.With no tax,the equilibrium price is$3.00 a pack.A tax on sellers of$1.50 a pack is introduced.Supply decreases and the curve S+tax on sellers shows the new supply curve.Taxes 2012 Pearson Addison-WesleyThe market price paid by buyers rises t
22、o$4.00 a pack and the quantity bought decreases.The price received by the sellers falls to$2.50 a pack.So with the tax of$1.50 a pack,buyers pay$1.00 a pack more and sellers receive 50 a pack less.Taxes 2012 Pearson Addison-WesleyA Tax on BuyersAgain,with no tax,the equilibrium price is$3.00 a pack.
23、A tax on buyers of$1.50 a pack is introduced.Demand decreases and the curve D tax on buyers shows the new demand curve.Taxes 2012 Pearson Addison-WesleyThe price received by sellers falls to$2.50 a pack and the quantity decreases.So with the tax of$1.50 a pack,buyers pay$1.00 a pack more and sellers
24、 receive 50 a pack less.The price paid by buyers rises to$4.00 a pack.Taxes 2012 Pearson Addison-WesleySo,exactly as before when sellers were taxed:Buyers pay$1.00 of the tax.Sellers pay the other 50 of the tax.Tax incidence is the same regardless of whether the law says sellers pay or buyers pay.Ta
25、xes 2012 Pearson Addison-WesleyTax Incidence and Elasticity of DemandThe division of the tax between buyers and sellers depends on the elasticities of demand and supply.To see how,we look at two extreme cases.Perfectly inelastic demand:Buyers pay the entire tax.Perfectly elastic demand:Sellers pay t
26、he entire tax.The more inelastic the demand,the larger is the buyers share of the tax.Taxes 2012 Pearson Addison-WesleyPerfectly Inelastic DemandDemand for this good is perfectly inelasticthe demand curve is vertical.When a tax is imposed on this good,buyers pay the entire tax.Taxes 2012 Pearson Add
27、ison-WesleyPerfectly Elastic DemandThe demand for this good is perfectly elasticthe demand curve is horizontal.When a tax is imposed on this good,sellers pay the entire tax.Taxes 2012 Pearson Addison-WesleyTax Incidence and Elasticity of SupplyTo see the effect of the elasticity of supply on the div
28、ision of the tax payment,we again look at two extreme cases.Perfectly inelastic supply:Sellers pay the entire tax.Perfectly elastic supply:Buyers pay the entire tax.The more elastic the supply,the larger is the buyers share of the tax.Taxes 2012 Pearson Addison-WesleyPerfectly Inelastic SupplyThe su
29、pply of this good is perfectly inelasticthe supply curve is vertical.When a tax is imposed on this good,sellers pay the entire tax.Taxes 2012 Pearson Addison-WesleyPerfectly Elastic SupplyThe supply of this good is perfectly elasticthe supply curve is horizontal.When a tax is imposed on this good,bu
30、yers pay the entire tax.Taxes 2012 Pearson Addison-WesleyTaxes in PracticeTaxes usually are levied on goods and services with an inelastic demand or an inelastic supply.Alcohol,tobacco,and gasoline have inelastic demand,so the buyers of these items pay most the tax on them.Labor has a low elasticity
31、 of supply,so the sellerthe workerpays most of the income tax and most of the Social Security tax.Taxes 2012 Pearson Addison-WesleyTaxes and EfficiencyExcept in the extreme cases of perfectly inelastic demand or perfectly inelastic supply when the quantity remains the same,imposing a tax creates ine
32、fficiency.Figure 6.10 shows the inefficiency created by a$20 tax on MP3 players.Taxes 2012 Pearson Addison-WesleyWith no tax,marginal social benefit equals marginal social cost and the market is efficient.Total surplus(the sum of consumer surplus and producer surplus)is maximized.The tax decreases t
33、he quantity,raises the buyers price,and lowers the sellers price.Taxes 2012 Pearson Addison-WesleyMarginal social benefit exceeds marginal social cost and the tax is inefficient.The tax revenue takes part of the total surplus.The decreased quantity creates a deadweight loss.Taxes 2012 Pearson Addiso
34、n-WesleyTaxes and FairnessEconomists propose two conflicting principles of fairness to apply to a tax system:The benefits principleThe ability-to-pay principleTaxes 2012 Pearson Addison-WesleyThe Benefits PrincipleThe benefits principle is the proposition that people should pay taxes equal to the be
35、nefits they receive from the services provided by government.This arrangement is fair because it means that those who benefit most pay the most taxes.Taxes 2012 Pearson Addison-WesleyThe Ability-to-Pay PrincipleThe ability-to-pay principle is the proposition that people should pay taxes according to
36、 how easily they can bear the burden of the tax.A rich person can more easily bear the burden than a poor person can.So the ability-to-pay principle can reinforce the benefits principle to justify high rates of income tax on high incomes.Taxes 2012 Pearson Addison-WesleyIntervention in markets for f
37、arm products takes two main forms:Production quotas SubsidiesA production quota is an upper limit to the quantity of a good that may be produced during a specified period.A subsidy is a payment made by the government to a producer.Production Quotas and Subsidies 2012 Pearson Addison-WesleyProduction
38、 QuotasWith no quota,the price is$30 a ton and 60 million tons a year are produced.With the production quota of 40 million tons a year,quantity decreases to 40 million tons a year.The market price rises to$50 a ton and marginal cost falls to$20 a ton.Production Quotas and Subsidies 2012 Pearson Addi
39、son-WesleyProduction Quotas and SubsidiesInefficiencyAt the quantity produced,marginal social benefit equal market price,which has increased.marginal social cost has decreased.Production is inefficient and producers have an incentive to cheat.2012 Pearson Addison-WesleySubsidiesWith no subsidy,the p
40、rice is$40 a ton and 40 million tons a year are produced.With a subsidy of$20 a ton,marginal cost minus subsidy falls by$20 a ton and the new supply curve is S subsidy.Production Quotas and Subsidies 2012 Pearson Addison-WesleyThe market price falls to$30 a ton and farmers increase the quantity to60
41、 million tons a year.With the subsidy,farmers receive more on each ton soldthe price of$30 a ton plus the subsidy of$20 a ton,which is$50 a ton.But farmers marginal cost increases to$50 a ton.Production Quotas and Subsidies 2012 Pearson Addison-WesleyInefficient OverproductionAt the quantity produce
42、d:marginal social benefit equals the market price,which has fallen.marginal social cost has increased and exceeds marginal social benefit.Production Quotas and Subsidies 2012 Pearson Addison-WesleyMarkets for Illegal GoodsThe U.S.government prohibits trade of some goods,such as illegal drugs.Yet,mar
43、kets exist for illegal goods and services.How does the market for an illegal good work?To see how the market for an illegal good works,we begin by looking at a free market and see the changes that occur when the good is made illegal.2012 Pearson Addison-WesleyA Free Market for a DrugFigure 6.13 show
44、s the market for a drug such as marijuana.Market equilibrium is at point E.The price is PC and the quantity is QC.Markets for Illegal Goods 2012 Pearson Addison-WesleyPenalties on SellersIf the penalty on the seller is the amount HK,then the quantity supplied at a market price of PC is QP.Supply of
45、the drug decreases to S+CBL.The new equilibrium is at point F.The price rises and the quantity decreases.Markets for Illegal Goods 2012 Pearson Addison-WesleyPenalties on BuyersIf the penalty on the buyer is the amount JH,the quantity demanded at a market price of PC is QP.Demand for the drug decrea
46、ses to D CBL.The new equilibrium is at point G.The market price falls and the quantity decreases.Markets for Illegal Goods 2012 Pearson Addison-WesleyBut the opportunity cost of buying this illegal good rises above PC becausethe buyer pays the market price plus the cost of breaking the law.Markets f
47、or Illegal Goods 2012 Pearson Addison-WesleyPenalties on Both Sellers and BuyersWith both sellers and buyers penalized for trading in the illegal drug,both the demand for the drug and the supply of the drug decrease.Markets for Illegal Goods 2012 Pearson Addison-WesleyThe new equilibrium is at point
48、 H.The quantity decreases to QP.The market price is PC.The buyer pays PB and the seller receives PS.Markets for Illegal Goods 2012 Pearson Addison-WesleyLegalizing and Taxing DrugsAn illegal good can be legalized and taxed.A high enough tax rate would decrease consumption to the level that occurs when trade is illegal.Arguments that extend beyond economics surround this choice.Markets for Illegal Goods