Business Educators Conference BLACKLOW

Business Educators Australasia 2016 Biennial Conference

© University of Tasmania - CRICOS Provider Code 00586B

Using Public Policy to Teach Economics -

Economics, Teenagers and Policy

Dr Paul BlacklowTasmanian School Of Business & Economics

1

ECONOMICS, TEENAGERS AND POLICY

Teenagers, Revealed Preferences

and Optimal Choices

Elasticity, Smoking

and Tobacco Excise

Australian Education System Simplified

and Education Vouchers

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Teenagers, Revealed Preferences

and Optimal Choices


Teenagers• I’m no expert on teenagers (yet)

– but need to be, my eldest has just turned 13)

• Most people want their choices and actions to be respected.

– A little less so as we age.

• Teenagers especially want their choices and actions to be respected as recognition they are no longer children and becoming adults.


Revealed Preferences I• Preferences of individuals indicate which goods and

choices they prefer and indicate how enjoyment, life satisfaction or utility they receive from them.

• Preferences of individuals can be revealed by their purchasing habits and other choices.

– Samuelson (1938)


Utility Maximisation• Economists model individuals’ purchasing habits and

choices as the..

* maximisation of utility

* given time, money and other constraints.

• An individual’s utility is a function of their own unique tastes and preferences.

• We are unlikely to know another person’s complete set of preferences and tastes, but…


Revealed Preferences II• Each time an individual makes a choice or purchasing

decision they reveal a little of their preferences, given their constraints.

• If I am observed purchasing flat-white coffee and toasted vegetarian regularly for lunch.

• I must have preference for those goods for lunch given my time and income constraints.


Optimal Choices I• The observed purchases and choices an individual

makes can be considered the result of them

* maximising their own utility

* given their constraints.

• If individuals are rational and free to make their own decisions then will choose what is best for them.

• Their purchases and choices are optimal for them given their preferences and constraints!


Optimal Choice Eg.1• If Sam chooses to spend all Saturday morning

sleeping in.

• It is his optimal choice, given his

* preferences (maybe enjoys/needs sleep)

* constraints (little money, more time)


Optimal Choices Eg.1• You might try dragging Sam out of bed!

• You may have some knowledge of his constraints

• But unlikely to know his full preferences or the extent to which certain choices bring utility.

– He might enjoy sleeping a tremendous amount ???

– He may gain very little utility from other activities???


Optimal Choices Eg.2• If Lily chooses to spend Saturday mornings at

Salamanca market.

• It is her optimal choice, given her

* preferences (maybe enjoys markets, fresh air)

* constraints (little time, more money)


Optimal Choices Eg.2• You might try persuading Lily to do something

different.

• But unlikely to know her full preferences or the extent to which certain choices bring utility.

– She may gain very little utility from sleeping in or other activities ???

– She may have strong preference for outdoor and/or cultural and/or shopping activities ???

– She may have a information constraint of not knowing what else to do???


Optimal Choices - Summary• If rational and not suffering from too many

information constraints…

• Everyone’s (including teenagers)

• Choices are optimal.

• Whenever I question my youngest 7yo daughter’s distaste for tomatoes.

• “Daaaad, everyone has different tastes”

• “They might be best for you, but they are not best for me”


Elasticity, Smoking

and Tobacco Excise


Price Elasticity• Price Elasticity measures how responsive market is to

a change in price.

• Price Elasticity of Demand

where P is price, Q is quantity

• The own price elasticity is negative for all (non-giffen) goods and so the negative sign is often ignored by using the absolute value

%

% P

Q


Price Elasticity

• How do we use it? Re-arranging the above gives

• Thus if the price elasticity of demand is –1.37 a 10% rise in the price of the good is likely to cause a fall in sales of 13.7%.

% % PQ


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Price Elasticity

• If > 1 then demand is elastic (responsive to price) and %Q > %P

• If < 1 then demand is inelastic (unresponsive to price) and %Q < %P

• If = 1 then demand is unit elastic and %Q = %P

Australian Tobacco Use 2011-12

• 3 million (15% of the 20 million Australian adults) regularly smoke tobacco)– ABS 4364.0.55.003 - Australian Health Survey: Updated Results, 2011-2012.

• Spent approximately $13.5 billion on tobacco.– ABS 5206.0 Australian National Accounts: national income, expenditure and

product, Table 8.

• 1.7% of total Household spending and 0.94% of GDP. – ABS 5206.0 Australian National Accounts: national income, expenditure and

product, Table 1 and Table 8.


Australian Tobacco Tax 2011-12

• The federal and state governments raised approximately

– $7.50 billion from tobacco excise taxes

– $1.23 billion on the GST from tobacco.– ABS 5506.0 - Taxation Revenue, Australia

• The total excise tax rate on tobacco is %157 and then the GST is applied at 10%– http://www.tobaccoinaustralia.org.au


http://www.tobaccoinaustralia.org.au/

Tobacco Elasticity

• The elasticity of the total tobacco expenditure(including all taxes) with respect to the after tax price is

xp = ∆%x/∆%p = -0.25

• The elasticity of the number of smokers with respect to the price is

np = ∆%n/∆%p = -0.25


The Tax on Tobacco

• Total tobacco excise tax is %157 and the GST of 10% is applied on top of that

• The final after tax price p given the producer price pP is

p = pP x (1+t) x (1+gst)

= pP x 2.57 x 1.1

= 2.827 pP


The Tax on Tobacco

• By setting pP=1 our quantity is measured in pre-tax dollars of tobacco.

• Since x = p q then q = x / p

• With x0 = $13.5b and p0=2.827

q0 = $4.775b pre-tax $ of tobacco


Tobacco Excise 200%

Consider the effect of raising the excise rate from 157% to 200%.

• The final after tax price p is

p = 1 x (1+t) x (1+gst)

= 1 x 3.00 x 1.1

= 3.30


Tobacco Excise 200%

How much does the price increase?

• Given p0 = 2.827 p1 = 3.300

%Δp = (p1-p0 )/p0

= (3.300 – 2.827) / 2.827

= 0.473 / 2.827

= 0.167315

= 16.73%


Tobacco Excise 200%

How many smokers would give up?

• Given np = ∆%n/∆%p = -0.25

%Δp = 16.73%

∆%n = np x ∆%p

= - 0.25 x 16.73%

= - 4.2%

• 0.125m smokers (4.2% of 3m smokers)


Tobacco Excise 200%

How much would the remaining smokers spend?

• Given xp = ∆%x/∆%p = -0.25

%Δp = 16.73%

∆%x = np x ∆%p

= - 0.25 x 16.73%

= - 4.2%

• Total expenditure will decrease by 4.2%


Tobacco Excise 200%

How much would the remaining smokers spend?

• A 4.1829% decrease in the total tobacco expenditure of $13.5b is -$0.565b.

• So the remaining smokers would spend $12.935b in total.


Tobacco Excise 200%

How much pre-tax tobacco would they buy?

• Since the price-including tax is p1 = 3.30 and the total expenditure is x1 $12.935b

q1 = x1 / p1

=$12.935b / 3.30

= $3.920b of pre-tax tobacco.


Tobacco Excise 200%

How much GST and excise tax per year would be raised from tobacco by the government?

$3.920b x 200%

= $7.840b in excise tax.

$3.920b x 300% x 0.10

= $1.176b in GST


Tobacco Excise 200%

By how much does the policy change government revenue per year?

Δ Excise Tax

= $7.840 b - $7.500 b = $0.340 b

Δ GST

= $1.176 b - $1.230 b = -$0.054 b

• Over all the government revenue increases by $0.285 Billion per year.


External Smoking Costs


External Costs2004-05

($m)2011-12

($m)

2011-12($ per

smoker)

Health (net) $318 $389 $130

Production in the workplace $5,749 $7,028 $2,343

Production in the home $9,843 $12,032 $4,011

Fires $63 $77 $26

Resources used in abusive consumption $3,636 $4,444 $1,481

Less consumption resources saved $7,583 $9,269 $3,090

Total Tangible Costs $12,026 $14,700 $4,900

Intangible Costs(Loss of Life) $19,460 $23,787 $7,929

Total Cost $31,486 $38,487 $12,829

Collins D., and Lapsley H., (2008) The Cost of Tobacco, Alcohol and Illicit Drug Abuse to Australian Society in 2004/05, Commonwealth of Australia, Department of Health and Ageing

Tobacco Excise 200%

0.125m Smokers that give up?

• Initially personally worse off as they adjust.

• Reduce costs to society by

– $12,829 x 0.125 m = $1,603m


Tobacco Excise 200%

2.875m Smokers that remain?

• Personally worse off!

• Paying 16% more for the same product.

• Cut their smoking spending by 4% so could estimate a 4% cut in costs to society by

– $12,829 x 4.875 m x 4% = $1,475m


Tobacco Excise 200%

17 Million Non-Smokers ?

• No personal effect

• But Government budget balance improves by $0.285 billion.

• And external social costs have been reduced by $3b.


Australian Education System Simplified and Education Vouchers



• There are approximately 2 million public school students in Australia and 1 million private school students.

• The Federal and State governments combined spend approximately $48 billion on public education and $12 billion on private education per year.

• Private schools raise an additional $12 billion from fees per year.

• Assume that public and private schools are equally efficient, so that $1 of funding to either system has the same effect.


Minister for

Education –

Senator Simon

Birmingham


1 million private students

• $12b from government + $12b from fees

• The average funding per student is $24,000 per student.

• Price is effectively $0.50 per $ of education


• $24b from government

• The average funding per student is $24,000 per student.

• Price is effectively $0.00 for $24,000 of education



If parents are willing to pay less than $12,000 on their child’s education. Suppose they are WTP = $8,000.

Private: $8,000 from parents at $0.50 per $ of education

$16,000 worth of educationvs

Public: $0 from parents + $24,000 from government

$24,000 worth of education

Public Education is a clear choice

it has more education and more money for parents.



If parents are willing to pay more than $12,000 on their child’s education. Suppose WTP = $16,000.

The choice between -$16000 and $32,000 education vs

$0 and $24,000 education

Would normally be determined by preferences and we could not know someone’s choice.

Except that we have assumed they are willing to pay $8000 and

So will choose private education.




• Have parents with WTP greater than $12,000

2 million public students

• Have parents with WTP less than $12,000

• WTP incorporates income and other constraints as well as preferences for education.


A (Revenue Neutral) Education Voucher

• If the all government education funding of $60b was shared out equally to all 3 million students as a education voucher it would be worth $60,000 million/ 3 million =

$20,000 per student.

• There would be no public schools.

• There would be no government funding to private schools (other than the voucher) so that price of education becomes $1.00 for a $ of education.



Does the voucher system make parents better off?

• Yes for some no for others!

• Can you identify which types of parents would be better off and worse off?

Will it result in better student outcomes?

• Yes for some no for others!

• Can you identify which students would have better outcomes or worse outcomes?



Consider who parents were WTP less than $12,000 on their child’s education.

Existing System

Spend $0 and get $24,000 worth of public education.




Suppose their WTP was $4,000

If they spend the same as before $0 + $20,000 voucher now they will get $20,000 worth of education ($4,000 less education).or

If they spend $4,000 + $20,000 voucher they will get the same amount of education as before $24,000 ($4,000 less money)

Worse off




If their WTP does not change at all they will still wish willing to pay $4000 + $20000 voucher and so a student would receive the same education $24,000 worth for WTP = $4000.

If WTP = $2000 then students get $22,000 education



if WTP < 4000 less education

if WTP > 4000 more education



Consider who parents were WTP more than $12,000 but less than $20,000 on their child’s education.

For example suppose their WTP was $16,000.

Existing System

Spend $16,000 to get $32,000 worth of private education.



Consider who parents were WTP more than $12,000 but less than $20,000 on their child’s education.

If they spend the same as before $16,000 and their voucher now they will get $36,000 worth of education ($4,000 more education).

or

If they spend $12,000 + $20,000 voucher they will get the same amount of education as before $32,000 ($4,000 more money)

Better off (and more education, if no change in WTP)



Consider parents who were WTP more than $20,000 on their child’s education.

Suppose their WTP was $30,000.

Existing System

Spend $30,000 and get $60,000 worth of private education.



Consider parents who were WTP more than $10,000 on their child’s education.

Voucher System

If they spend the same $30,000 + $20,000 voucher they will get $50,000 worth of education ($10,000 less education).

If they spend $40,000 + $20,000 voucher they will get $60,000 worth of education (but have $10,000 less money)

Worse off (and less education, if no change in WTP)


A (Revenue Neutral) Education VoucherExtensions

• Could discuss and examine changes to WTP.

• Reaction to vouchers.

• Probably should split private into independent and other (mainly Catholic) schools.


The End


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