ECN212 Chapter 4 - Economics of the Public Sector Chapter 4 Fiscal Finance and government spending The avoidance of taxes is the only intellectual

ECN212 Chapter 4 - Economics of the Public Sector Chapter 4...

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Economics of the Public Sector Chapter 4 Fiscal Finance and government spending 1 “We contend that for a nation to try to tax themselves into prosperity is a little like a man standing in a bucket and trying to lift himself up by the handles” Winston Churchill, British statesman “Income tax returns are the most imaginative fiction being written today”. Herman Wouk, author of the Caine Mutiny, Winds of War, and War & Remembrance. “The avoidance of taxes is the only intellectual pursuit that carries any reward”. John Maynard Keynes, economist. “The United States is the only country in the world where it takes more brains to figure out what you owe in taxes than it took to make the money in the first place”. Ronald Reagan, actor, governor, and 40 th President of the United States.
Economics of the Public Sector - The first day of class I gave you this definition of economics… …economics is a social science that studies how society allocates scarce resources among different and competing alternative uses. - Under the topic of allocates I told you that individuals ( i.e ., consumers and business) respond to both incentives and 2
Economics of the Public Sector - How do we get people to respond to incentives and disincentives? By using the Price System . - If the government wants you to do more of something, they will just give it to you or provide you with a subsidy to get it (which effectively lowers the price ). - If the government doesn't want you doing something they 3
Economics of the Public Sector - So to see how taxes affect prices and how they relate to public policy we need some further discussion. - Recall from Chapter 6 that taxes are inefficient. While they allow the government to collect revenue to buy stuff for us (as well as give us subsidies) they create a deadweight loss. - That deadweight loss is what happens when consumers or business have an incentive or disincentive to do something that they ordinarily wouldn’t have done in the market place. 4
Market Efficiency Consumer surplus is above price and below demand Producer surplus is below price and above supply D S P 1 Q 1 Quantity Consumer Surplus Producer Surplus Price Consumer surplus is value consumers get that they didn’t have to pay for Producer surplus is value the producer didn’t expect to get
Market Inefficiency If the tax is placed on the business (increase in cost of production) Creates a deadweight loss of a1 and a2. This is the (surplus) value lost due to the tax. Demand Supply with no tax P 1 Q 1 Quantity Q 2 P 2 Supply with tax a 1 a 2 In addition to the deadweight loss (a 1 and a 2 ), consumers also lose t 1 and producers also lose t 2 . The t 1 and t 2 area is tax revenue collected by the government Price t 1 t 1 t 2 t 2
Market Inefficiency Tax placed on consumer (increase in price sort of like a price floor) Demand Supply P 1 Q 1 Quantity Q 2 P 1 + tax a 1 a 2 Same deadweight loss (a 1 + a 2 ). In addition, consumers also lose t 1 and producers also lose t 2 .

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