EC2101_Lecture12.pdf

# EC2101_Lecture12.pdf - LECTURE 12 GOVERNMENT INTERVENTIONS...

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LECTURE 12 GOVERNMENT INTERVENTIONS FINAL REVIEW April 4, 2012

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Where are we? LECTURE 12 EC2101 Semester 1 AY 2016/2017 Demand • UKlity MaximizaKon Supply • Cost MinimizaKon • Profit MaximizaKon Free Market Equilibrium 2
Part 1 Welfare of Tax and Subsidy LECTURE 12 EC2101 Semester 1 AY 2016/2017

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Welfare when There is No Tax LECTURE 12 EC2101 Semester 1 AY 2016/2017 P 0 Q 10 1 S ( P ) 3 5 20 X 7 D ( P ) 9 A B C D E F CS=A+B+C PS=D+E+F TS=A+B+C+D+E+F 4
CalculaKng Welfare when There is No Tax ¨ Equilibrium is at point X ¨ Equilibrium price is \$5 and equilibrium quanKty is 20 ¨ Consumer surplus=1/2*20*(9-5)=40 ¨ Producer surplus=1/2*20*(5-1)=40 ¨ Total surplus=40+40=80 LECTURE 12 EC2101 Semester 1 AY 2016/2017 5

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Welfare when There is a \$4 Excise Tax LECTURE 12 EC2101 Semester 1 AY 2016/2017 P 0 Q 10 1 S ( P ) 5 20 X Y D ( P ) 9 A B C D E F CS=A PS=F Tax=B+D TS=A+B+D+F Price for consumers=7 Price for producers=3 S 1 ( P ) 6
CalculaKng Welfare when There is Tax ¨ Equilibrium is at point Y ¨ Market equilibrium price is \$7 (the price consumers pay) and equilibrium quanKty is 10 ¨ Producers receive a price of \$3 ¨ Consumer surplus=1/2*10*(9-7)=10 ¨ Producer surplus=1/2*10*(3-1)=10 ¨ Tax=4*10=40 ¨ Total surplus=10+10+40=60 LECTURE 12 EC2101 Semester 1 AY 2016/2017 7

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Deadweight Loss with Tax LECTURE 12 EC2101 Semester 1 AY 2016/2017 P 0 Q 10 1 S ( P ) 5 20 X Y D ( P ) 9 C E Deadweight loss=C+E Price for consumers=7 Price for producers=3 S 1 ( P ) CS PS Tax 8
CalculaKng Deadweight Loss ¨ ReducKon in total surplus due to tax ¨ Total surplus before tax=80 ¨ Total surplus ager tax=60 ¨ Deadweight loss=80-60=20 ¨ Deadweight loss is also the area of C+E ¤ =1/2*(7-3)*(20-10)=20 LECTURE 12 EC2101 Semester 1 AY 2016/2017 9

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Where does deadweight loss of tax come from? ¨ In the equilibrium with tax, there is quan%ty distor%on ¤ Specifically, we have underproducKon ¨ Area C: consumers who would have bought cigareies when there is no tax now do not buy ¨ Area E: producers who would have supplied cigareies when there is no tax now do not supply LECTURE 12 EC2101 Semester 1 AY 2016/2017 10
ElasKcity and Tax Burden: If demand is relaKvely inelasKc at point X LECTURE 12 EC2101 Semester 1 AY 2016/2017 P 0 Q S ( P ) X Y D ( P ) 10 S 1 ( P ) B D Increase in consumers’ price Decrease in producers’ price 8 11

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ElasKcity and Tax Burden: If demand is relaKvely elasKc at point X LECTURE 12 EC2101 Semester 1 AY 2016/2017 P 0 Q S ( P ) X Y D ( P ) 10 S 1 ( P ) B Increase in consumers’ price Decrease in producers’ price D 3 12
Incidence of a Tax LECTURE 12 EC2101 Semester 1 AY 2016/2017 ¨ How tax burden is shared between consumers and producers depend on the relaKve elasKcity of supply and demand ¨ If demand is inelasKc relaKve to supply ¤ Consumers bears most of the tax burden ¨ If demand is elasKc relaKve to supply ¤ Tax burden falls mostly on producers 13

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