Chapter 15 Market Interventions Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written.

chapter 15

Market Interventions

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

15-2

Learning Objectives

• Describe the effects of a tax or subsidy in a competitive market.

• Explain what determines who bears the burden of tax and the difference between the statutory and economic incidence of the tax.

• Compare the results of price floors, price supports, production quotas, and voluntary production reduction programs.

• Show the effects of a price ceiling.• Define domestic aggregate surplus and determine the

effects of import tariffs and quotas.


15-3

Overview

• Government interventions usually alter market outcomes. We will focus on:– Taxes and subsidies– Policies designed to raise or decrease prices– Import tariffs and quotas


15-4

Taxes

• Governments tax goods to raise the revenue needed to pay public expenditures

• There are different kinds of taxes. We will focus on two:– Specific tax: a fixed dollar amount that must be paid on

each unit bought or sold– Ad valorem tax: a tax that is stated as a percentage on the

good’s price


Effects of a Specific Tax• Point A shows the

market equilibrium

• Point B shows the increase in the price paid by consumers due to the tax

• Point C shows the decrease in the price received by producers due to the tax

Gallons of gas per month

Pric

e pa

id b

y bu

yers

($/g

allo

n)

D

SP0 + T

S1

P0

Q0

A

Pb

QT

B

PS = Pb - T C

Increase in consumers’ cost per gallon

Decrease in gas stations’ receipts per gallon

Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 15-5

15-6

Incidence of a Specific Tax

• Incidence: how much of the tax burden is borne by various market participants


Incidence of a Specific Tax• Sellers bear the entire burden of the tax


Incidence of a Specific Tax• Buyers bear the entire burden of the tax


15-9

Incidence of a Specific Tax

• The more elastic demand is, and the less elastic supply is, more of the tax is borne by seller

• For small taxes:– ds

s

EE

EshareBuyers

= '


Effects of a Specific Tax: Shifting the Demand Curve

• Point A shows the market equilibrium

• Point B shows the increase in the consumer’s cost due to the tax

• Point C shows the decrease in the producer’s profit due to the tax

• Regardless of who is taxed by the government, the incidence remains the same

Gallons of gas per month

Pric

e pa

id b

y bu

yers

($/g

allo

n)

D

S

Pb = PS - T

QT

B

P0

Q0

A

PS C

Decrease in gas stations’ receipts per gallon

Increase in consumers’ cost per gallon

P0 + T

DT

T


Welfare Effects of a Specific Tax

• Deadweight loss of taxation: lost aggregate surplus due to a tax

DWL


Welfare Effects of a Specific Tax


15-13

Which Goods should the Government Tax?

• Tax goods for which the deadweight loss of taxation will be low

• Deadweight loss of taxation will be low if either the demand or the supply curve is very inelastic


Taxation with No Deadweight Loss


Subsidies

• Subsidy: payment that reduces the amount that buyers pay for a good or increases the amount that sellers receive

• In competitive markets, subsidies create deadweight loss


15-16

Policies that Raise Prices

• Price floors• Price supports• Production quotas• Voluntary production reduction


Price Floors

• Price floor: establishes a minimum price that sellers can charge

Quantity traded

Price floor


Price Supports

• Price support: raises the market price by making purchases of the good, thereby increasing demand

Quantity traded


Production Quota

• Production quota: imposes limits on the quantity that individual firms can produce

Quantity traded


Voluntary Production Reductions

• Voluntary production reduction: offers firms inducements to reduce their production voluntarily

Quantity traded


Policies that Raise Prices and their Welfare Effects


Policies that Lower Prices

• Price ceiling: establishes a maximum price that sellers can charge

Quantity traded

Price ceiling


15-23

Tariffs

• Tariff: tax on importsEquilibrium with and without tariff

Tons of sugar per year

Dom

estic

pric

e ($

/ton

)

Sd

ST

D

P0 = PW

Q0dQ0

PT = PW + T

QT

S0


Welfare Effects of a Tariff


Quotas

• Quota: limits the total quantity of a good that can be imported

Tons of sugar per year

Dom

estic

pric

e ($

/ton

)

Sd

D

P0 = PW

Q0d0Q

S0

PT = PW + T

QTdTQ

SQ

Quota = (QT - )dTQ


15-26

Beneficial Trade Barriers

• When the import supply curve is upward sloping, a government can reduce the price received by foreign firms by imposing a tariff.

• Sometimes the domestic benefit from this effect may exceed the deadweight loss created by the tariff, increasing the aggregate domestic surplus


15-27

Review

• The effects of a tax are independent of who is legally required to pay it, whether buyers or sellers.

• The economic incidence of a tax depends on the elasticities of demand and supply. The more elastic demand is and the less elastic supply is, the smaller the share of the tax is borne by consumers.

• Policies designed to raise or lower competitive prices create deadweight loss.


15-28

Looking Forward

• Until now we have studied markets one at a time. But what are the ripple effects on other markets?

• General equilibrium analysis studies the simultaneous competitive equilibrium in multiple markets, and it will allow us to understand the consequences of interdependence between markets.


Chapter 15 Market Interventions Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written.

Documents

tax copyright

burden of tax

tax burden

specific tax incidence

specific tax point

specific tax buyers

specific tax sellers

tax point c