ECON 200 Chapter 6 Notes
ECON 200 Chapter 6 Notes ECON 200
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This 4 page Class Notes was uploaded by Lucy Notetaker on Friday September 23, 2016. The Class Notes belongs to ECON 200 at University of Maryland taught by Dr. Robert Schwab in Fall 2016. Since its upload, it has received 143 views. For similar materials see Principles of Economics: Microeconomics in Economics at University of Maryland.
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Date Created: 09/23/16
Chapter 6: Government Intervention Beyond just the economical aspects of our country, there are also political aspects that are pretty important too. Why Intervene? - For the most parts, markets are pretty good at taking care of themselves, but sometimes they need some help - There are three reasons to intervene 1. Correcting Market Failures- First let’s define a market failure- it is situations in which the assumption of efficient competitive markets fail to hold. An example of this would be a monopoly or a product that puts heavy air pollution into atmosphere. 2. Changing the Distribution of Surplus- Some people are making a lot more surplus than others. Basically this is a fancy way of saying close the gap between classes. The minimum wage is a good illustration of this example. 3. Encouraging or discouraging consumption- “Bad” products can be taxed while subsidies can promote good products. Let’s say if America wanted to reduce obesity, they could tax Twinkies while offering subsidies to broccoli farmers so that they can produce more. - Two types of analysis… 1. Positive analysis- based on facts 2. Normative analysis- based on values and opinions Price Controls - Price Control: a regulation that sets a maximum or minimum legal price for a particular good Price Ceilings - Price Ceilings- a maximum legal price at which a good can be sold - The good thing about this is it keeps “important” goods affordable and will increase quantity demanded - Bad news is low prices mean less producers want to produce it - This will mess with the equilibrium and can lead to a shortage - Deadweight Loss- a loss of total surplus that occurs because the quantity of a good that is bought and sold is below the equilibrium quantity - With shortage comes rationing and that can open the door to bribes and corruption to get rare goods (rent-seeking behavior) - But, say the ceiling is set above the equilibrium price…we call this non binding because it will not change quantity demanded or supplied Price Floors - Price Floor- a minimum legal price at which a good can be sold - Typically this is seen with agricultural goods, like milk - This has the opposite issue, it will increase the supply, but if prices are going up, then quantity demanded will fall - Producer surplus goes up, but total surplus goes down - One thing the government may do is buy up the extra supply- but that’s using your tax payer dollars - But it’s not always binding, sometimes the price floor is below the market price Taxes and Subsidies - Just to be clear, a tax is a cost imposed on either buyers or sellers which raises revenue for the government - Taxes both discourage consumption and raise revenue - Let’s looks at what happens when there is a tax imposed on a seller 1. Supply decreases (producer must pay more therefore why supply more) 2. Demand stays the same (tax is on the seller, not buyer) 3. The equilibrium price rises, but quantity demanded falls (back to as price goes up, demand goes down) - Tax Wedge- the difference between a price paid by buyers and price received by sellers - Math Time (Tax Wedge=$ paid from buyers-$ received by sellers=Tax) - One more (Government tax revenue=Tax * Equilibrium Quantity (post tax) - So in this scenario, both producers and consumers lose surplus, but government gains revenue - So let’s look at a tax on buyers (6% sales tax) 1. The supply curve stays the same 2. The Demand will decrease 3. The equilibrium price and quantity both fall - Whether you tax sellers of buyers, these things will consistently happen 1. Equilibrium quantity falls 2. Buyers pay more and sellers receive less 3. The government receives revenue equal to that second equation 4. The tax causes a deadweight loss, reduction is total surplus is always larger than revenue collected - Tax Incidence- the relative tax burden borne by buyers and sellers - Sometimes buyers and sellers share an equal tax, but most of the time one side bears more of a burden - The more elastic side of the market will adjust to price changes and bear less of the burden - That’s a little tricky, so here’s an example. Let’s say you’re in love with this new perfume, but then there is a heavy tax on it. This is an elastic good, so you might just switch to another brand or buy nice lotions instead. Perfume is an elastic good; therefore producers will bear more of the burden of a tax. Subsidies - Subsidy- a requirement that the government pay an extra amount to consumers or producers of a good - Example: Here’s a personal story. My mom was going out to buy a new car and the government gave her some money under the condition that she buy a Chevrolet or an American made car. This helped promote our car manufacturing economy. - So let’s look at what a subsidy to sellers does 1. Supply will increase 2. Demand stays the same 3. The equilibrium price decreases and equilibrium quantity increases - It looks pretty good, because total surplus is increasing, but with taxpayer dollars - Let’s sum up subsidies with these three guidelines 1. Equilibrium quantity will increase 2. Buyers pay less and sellers receive more 3. The government pays for the subsidy (Subsidy price=amount of subsidy * New equilibrium quantity) Evaluating Government Interventions - Here are some rules, not the most interesting thing in the world, but these are important 1. Price controls have opposing impacts on quantity supplied and demanded (shortage or excess supply) whereas taxes and subsidies move supply and demand in the same direction (equilibrium is easier to reach when they are moving the same way) 2. Taxes discourage buying and selling, raise government revenue and impose a cost on both parties involved 3. Subsidies do the exact opposite of number 2, encourage, cost gov. and benefit both parties - So how much will a tax or subsidy change things, that depends on price elasticity. The more elastic a good is, the more a tax will change it - Side note: Page 144 has a great table that sums everything up and compares all the things the government will do - Some things to note…about imposing a tax 1. Both supply and demand are inelastic- super small decrease in equilibrium quantity 2. Demand is more elastic than supply- Equilibrium quantity decreases more 3. Supply is more elastic than demand- Quantity will still decrease 4. Supply and demand are both elastic- Equilibrium quantity will go down the most - Time is a big thing when it comes to this stuff. A price floor may not have much impact in the short run, but can lead to more in the long run - Elasticity is greater over a long period of time than a shorter one I’ll end this chapter with a thought provoking question. What do you think about taxes and government intervention? This could provide insight into your political party (the fiscal side at least). Why am I saying this? Voting season is coming up, so participate in your country. And ace this Econ test!
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