Chapter 4 Government Controls

Chapter 4 Government Controls - CHAPTER 4 Government...

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CHAPTER 4 Government Controls: How Management Incentives Are Affected Without bandying jargon or exhibiting formulae, without being superficial or condescending, the scientist should be able to communicate to the public the nature and variety of consequences that can reasonable be expected to flow from a given action or sequence of actions. In the case of the economist, he can often reveal in an informal way, if not the detailed chain of reasoning by which he reaches his conclusions, at least the broad contours of the argument. E. J. Mishan arlier chapters showed how the models of competitive and monopolistic markets illuminate the economic effects of market changes, such as an increase in the price of oil. This chapter will examine the use of government controls to soften the impact of such changes. We will consider four types of government control: excise taxes, price controls, consumer protection laws, and minimum-wage laws. As we will see, government controls can inspire management reactions that negate some of the expected effects of the controls. Who Pays the Tax? Most people are convinced that consumers bear the burden of excise (or sales) taxes. They believe producers simply pass the tax on to consumers at higher prices. Yet every time a new (or increased) excise tax is proposed producers lobby against it. If excise taxes could be passed on to consumers, firms would have little reason to spend hundreds of thousands of dollars opposing them. In fact, excise taxes do hurt producers. Figure 4.1 shows the margarine industry’s supply and demand curves, S 1 and D . In a competitive market, the price will end toward P 2 and the quantity sold toward Q 3 . If the state imposes a $0.25 tax on each pound of margarine sold and collects the tax from producers, it effectively raises the cost of production. The producer must now pay a price not just for the right to use resources, such as equipment and raw materials, but for the right to continue production legally. The supply curve, reflecting this cost increase, shifts to S 2 . The vertical difference between the two curves, P 2 and P 1 , represents the extra $0.25 cost added by the tax. E
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Chapter 4 Government Controls: How Management Incentives Are Affected 2 2 ____________________________________ Figure 4.1 The Economic Effect of an Excise Tax An excise tax of $0.25 will shift the supply curve for margarine to the left, from S 1 to S 2 . The quantity produced will fall from Q 3 to Q 2 ; the price will rise from P 2 to P 3 . The increase, $0.20, however, will not cover the added cost to the producer, $0.25. Given the shift in supply, the quantity of margarine produced falls to Q 2 and the price rises to P 3 . Note, however, that the price increase ( P 1 to P 2) is less than the vertical distance between the two supply curves (P 2 to P 1 ). That is, the price increases by less than the amount of the tax that caused the shift in supply. Clearly, the producer’s net has fallen. If the tax is $0.25, but the price paid by consumers rises only $0.20 ($1.20 -
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This note was uploaded on 04/10/2011 for the course BUSI 1100 taught by Professor Staff during the Spring '11 term at North Texas.

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Chapter 4 Government Controls - CHAPTER 4 Government...

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