Government Involvement #1-Price Controls: Floors and Ceilings #2-Subsidies #3-Excise Taxes #4-Externalities 1
Government Involvement
#1-Price Controls: Floors and Ceilings#2-Subsidies#3-Excise Taxes#4-Externalities
1
#1-PRICE CONTROLSWho likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon?
2
Qo
$5
4
3
2
1
P
10 20 30 40 50 60 70 80 3
D
S
Shortage(Qd>Qs)
Maximum legal price a seller can charge for a product.Goal: Make affordable by keeping price from reaching Eq.
Gasoline
Does this policy help consumers?
Result: BLACK
MARKETSPrice Ceiling
Price Ceiling
To have an effect,
a price ceiling must be
below equilibrium
Qo
$
4
3
2
1
P
10 20 30 40 50 60 70 80 4
D
SSurplus(Qd<Qs)
Minimum legal price a seller can sell a product.Goal: Keep price high by keeping price from falling to Eq.
Corn
Does this policy help
corn producers?
Price Floor
Price Floor
To have an effect,
a price floor must be
above equilibrium
Are Price Controls Good or Bad?To be “efficient” a market must maximize
consumers and producers surplus
Q
P
D
S
Pc
Qe
CS
PS
5
Are Price Controls Good or Bad?To be “efficient” a market must maximize consumers and
producers surplus
Price FLOOR
Q
P
D
S
Pc
QeQfloor
DEADWEIGHT LOSS The Lost CS and PS.
INEFFICIENT!
CS
PS
6
Are Price Controls Good or Bad?To be “efficient” a market must maximize consumers and
producers surplus
Q
P
D
S
Pc
Qe
CS
PS
7
Are Price Controls Good or Bad?To be “efficient” a market must maximize consumers and
producers surplus
Price CEILING
Q
P
D
S
Pc
QeQceiling
DEADWEIGHT LOSS The Lost CS and PS.
INEFFICIENT!CS
PS
8
#2 SubsidiesThe 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
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Result of Subsidies to Corn Producers
Qo
Price of Corn
Quantity of Corn 10
SSSubsidy
Price DownQuantity Up
Everyone Wins, Right?
Pe
P1
Qe Q1
D
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#3 Excise TaxesExcise Tax = A per unit tax on producers
For every unit made, the producer must pay $NOT a Lump Sum (one time only)TaxThe goal is 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.
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Excise Taxes
Qo
$5
4
3
2
1
P
13
Supply Schedule
P Qs
$5 140
$4 120
$3 100
$2 80
$1 60 D
S
40 60 80 100 120 140
Government sets a $2 per unit tax on Cigarettes
Excise Taxes
Qo
$5
4
3
2
1
P
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Supply Schedule
P Qs
$5 $7 140
$4 $6 120
$3 $5 100
$2 $4 80
$1 $3 60 D
S
40 60 80 100 120 140
Government sets a $2 per unit tax on Cigarettes
Excise Taxes
Qo
$5
4
3
2
1
P
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Supply Schedule
P Qs
$5 $7 140
$4 $6 120
$3 $5 100
$2 $4 80
$1 $3 60 D
S
40 60 80 100 120 140
Tax is the vertical distance between
supply curves
STax
Excise Taxes
Qo
$5
4
3
2
1
P
16
D
S
40 60 80 100 120 140
Identify the following:
1. Price before tax2. Price
consumers pay after tax
3. Price producers get after tax
4. Total tax revenue for the government before tax
5. Total tax revenue for the government after tax
S
#4 EXTERNALITIES
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•An externality is a third-person side effect.•There are EXTERNAL benefits or external costs to someone other than the original decision maker. Why are Externalities Market Failures?•The free market fails to include external costs or external benefits.•With no government involvement there would be too much of some goods and too little of others.Example: Smoking Cigarettes.
•The free market assumes that the cost of smoking is fully paid by people who smoke.
•The government recognizes external costs and makes policies to limit smoking.
What are Externalities?
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Negative Externalities
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Situation that results in a COST for a different person other than the original decision maker.
The costs “spillover” to other people or society.Example: Zoram is a chemical company that pollutes the air when it produces its good.
•Zoram only looks at its INTERNAL costs.•The firms ignores the social cost of pollution•So, the firm’s marginal cost curve is its supply curve•When you factor in EXTERNAL costs, Zoram is producing too much of its product.
•The government recognizes this and limits production.
Negative Externalities (aka: Spillover Costs)
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Video- Whistle Tips
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P
Q
D=MSB
Supply = Marginal
Private Cost
QFree Market
22
Market for CigarettesThe marginal private cost doesn’t include the
costs to society.
P
Q
D=MSB
Supply = Marginal
Private Cost
QFree Market 23
Market for Cigarettes
Supply = Marginal
Social Cost
What will the MC/Supply look like when EXTERNAL cost are factor in?
QOptimal
P
Q
D=MSB
S=MPC
QFree Market 24
Market for Cigarettes
S =MSC
QOptimal
At QFM the MSC is greater than the MSB.
Too much is being produced
If the market produces QFM why is it a market failure?
Overallocation
P
Q
D=MSB
QFree Market 25
Market for CigarettesWhat should the government do to fix a negative
externality?
QOptimal
S=MPC
S =MSC
Solution: Tax the amount of the
externality(Per Unit Tax)
P
Q
D=MSB
QFree Market 26
Market for CigarettesWhat should the government do to fix a negative
externality?
QOptimal
S=MPC
S =MSC
Solution: Tax the amount of the
externality(Per Unit Tax)
=MPC
MSB = MSC
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Positive Externalities
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Positive Externalities (aka: Spillover Benefits)
Situations that result in a BENEFIT for someone other than the original decision maker.
The benefits “spillover” to other people or society.(EX: Flu Vaccines, Education, Home Renovation)Example: A mom decides to get a flu vaccine for her child
•Mom only looks at the INTERNAL benefits.•She ignores the social benefits of a healthier society.•So, her private marginal benefit is her demand •When you factor in EXTERNAL benefits the marginal benefit and demand would be greater.
•The government recognizes this and subsidizes flu shots.
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P
Q
D=Marginal Private Benefit
S = MSC
QFree Market 30
Market for Flu ShotsThe marginal private benefit doesn’t include
the additional benefits to society.
P
QQFM 31
What will the MB/D look like when EXTERNAL benefits are factor in?
QOptimal
D=Marginal Private Benefit
S = MSC
D=Marginal Social Benefit
Market for Flu Shots
P
Q
D=MSB
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If the market produces QFM why is it a market failure?
S = MSC
D=Marginal Social Benefit
QFM QOptimal
Market for Flu Shots
P
Q 33
Underallocation
S = MSC
D=Marginal Social Benefit
QFM QOptimal
At QFM the MSC is less than the MSB.
Too little is being produced
Market for Flu Shots
P
QQFM 34QOptimal
D=MPB
S = MSC
D=MSB
What should the government do to fix a negative externality?
Subsidize the amount of the externality (Per Unit Subsidy)
=MPB
Market for Flu Shots
Economics of PollutionWhy are public bathrooms so gross?
The Tragedy of the Commons (AKA: The Common Pool Problem)
•Goods that are available to everyone (air, oceans, lakes, public bathrooms) are often polluted since no one has the incentive to keep them clean. •There is no monetary incentive to use them efficiently.•Result is high spillover costs.Example: Over fishing in the ocean 35
Perverse Incentives1. In 1970, the government tried to protect endangered
woodpeckers by requiring land developers to report nests on their land to the EPA.
The population of these bird decreased. Why? Land owners would kill the birds or else risk lengthy production delays. (Known as “Shoot, Shovel, and Shut Up”)
2. Assume the government wanted to limit a firm from polluting. They tell them they will inspect them twice and they must reduce pollution by 5%.
The amount of pollutants would increase. Why?These firm will have the incentive to pollute more prior to
inspection.Are their “market solutions” to these
problems? 36
How can markets and self interest help to limit pollution?
Government can sell the right to pollute
100
200
5050
100
Assume the lake can naturally absorb 500 gallons of pollutants
each year
Now what does each firm have the incentive
to do?
The Gov’t sells each firm the right to
pollute a set number of gallons