Sunday, September 14, 2014

Government Intervention 1 - Indirect Taxes

Government Intervention

Conversations welcome - Econowaugh on Facebook

Includes all of the following:
  • Indirect Taxes
  • Subsidies
  • Price Floors
  • Price Ceilings
  • What I like to call (world price)
Nixon imposes wage and price controls - 1971

Venezuelan President Nicolas Maduro, furthers Price Controls, 2013

Venezuela used cars. Price Controls

Indirect Taxes

Indirect taxes  - are taxes on the expenditure of goods and services. It increases the cost of production and shifts the supply curve to the left.

The vertical distance between the old and new supply curve is the size (amount) of the tax.
Governments impose indirect taxes for several reasons:
  • to finance government expenditures (raise revenue)
  • discourage socially undesirable activities (raises the taxes on gas to discourage driving)
  • promote economic growth (imposes tariffs to lower consumption of imported goods)
  • reduce inequality
Two types of Indirect taxes:
  • specific
  • ad valorem
Specific Tax - a tax on a good that is set as a fixed amount per UNIT.
                         ex. the government imposes a two dollar a pack cigarette tax.

Ad Valorem Tax - an indirect tax expressed as a percentage of the price of the product.
                                ex. VAT taxes - Value Added Tax - the government enforces a 20% tax on the                                             expenditure.

The best way to learn how to do tax intervention, cause and effect is to do an AP tax problem. Look closely at the graph and what is asked for in the question. The same structure is used for many of the Gov't intervention FRQ's.

1995 AP Microeconomics Exam - FRQ, #2

2) The graph above shows the market for a good that is subject to a per-unit tax

      (a) Using the labeling on the graph, identify each of the following:

  • The equilibrium price and quantity before the tax.
This is easy in that we just need to look at the original supply curve and trace the equilibrium price (12) and the equilibrium quantity (100).          
  • The  area representing the consumer surplus before the tax.  
Did you see the before the tax,,, Important, right! The consumer surplus before the tax is the sum of the A+B+C+F, area. 
  • The area representing the producer surplus before the tax.
I know you saw the before the tax this time,,, failure to read the question closely is a big problem with answering these questions correctly. The producer surplus before the tax is D+G+E, area or 100$.

(b) Assume that the tax is now imposed. Based on the graph, does the price paid         by the buyers rise by the full amount of the tax? Explain.

If we look at the old equilibrium price of ($12) and the after the tax, new equilibrium price of ($13) we can say that the price paid by consumers increased by $1 after the tax. But the question asks, does the price paid by the buyer rise by the full amount of the tax, since the tax is $2 per unit and the consumer only paid $1 of the tax,, the consumer in fact, did not pay the full amount of the tax.

Explain, why? - Remember that the vertical distance between the two parallel supply curves is equal, up and down the curves. With that in mind, look at the vertical line running down from the new, taxed, equilibrium to the new quantity of 80 units. Look at the original supply curve and recognize that if the distance between old and new supply curve is the amount of the tax,, then we can see that the tax increased the cost of the good by $2 from $11 to ($13 the new equilibrium amount). Draw a line straight down through the new (taxed) supply equilibrium and where it crosses the old supply curve will show you the amount of the tax.  

That's a lot of words. :0

OK, so we can see that the tax was $2 and the consumer paid only $1 of the tax,,, why??

Answer - The price paid by the buyer does not rise by the full amount,, and since supply and demand have the same elasticities both pay half. The more elastic the demand curve (flat) the more producers will bear the tax burden,,, the more elastic the supply curve the (flat) the more consumers will  bear the tax burden.

Nice graphic example:


(C) Using the labeling on the graph, identify each of the following after the                     imposition of the tax.

  • The net price received by the sellers.
Net price received by seller is $11 (net is what the seller actually puts in his pocket) after he pays his $1 to the government and the consumer pays his $1 to the government.
  • The amount of tax revenue.
 Tax revenue (money collected by the government from the tax)  is the areas B+C+D or $160.
The revenue is the $2 per unit tax times the number of units sold = 80,, so 2*80 = 160.
  • The area representing the consumer surplus.
Consumer surplus is A.
  • The area representing deadweight loss.
Deadweight loss is what has been lost by society due to the higher prices,,, they are looking for either an area or a quantity. The area of DWL (dead weight loss) is F+G. The quantity is 20 units.

Pajholden on Indirect Taxes - 

Welker on Indirect taxes - Elastic

Welker Indirect (excise) tax - Inelastic

1995 AP Microeconomics Exam

Answer - (D) The supply curve will shift to the left.

Government Intervention 3 - Price Ceilings

Price Controls - Price Ceilings 

Conversations welcome - 

Price Controls - refer to the setting above or below the market equilibrium (binding) by the                                   government. Price controls result in shortages and surpluses.

mjmfoodie video - Price floors and ceilings - 

Price Ceilings

Price Ceiling (max price), refers to the setting of the price lower than the market equilibrium by the government and no seller is allowed to sell the goods at a higher price than the maximum price.

Remember -  (Ceilings are low)

Ceilings are meant to help the consumers,,, with lower prices. Remember, the lower prices mean that quantity demand will increase, but from the producers standpoint lower prices are a incentive to supply less. So with a high quantity demanded and low quantity supplied we naturally have shortages.

Reasons for Price Ceilings:
  • To protect (help Buyers so that lower income households can afford the good or service. Ex. food price controls and rent controls.
  • to lower the price of goods that the government deems unreasonably high.
Impacts of Price Ceilings:

1.     Non-Price rationing emerges - When a price ceiling is imposed, Qd exceeds Qs. Shortages           occur. Therefore, sellers have to ration the goods using non-price rationing mechanisms,             such as lines, first-come, first-served, nepotism (favors,  me and mine first).
2.     Underground Parallel Markets (Black Markets) - Those who cannot obtain the goods                   desired on the regular market may seek to buy the goods at higher prices at the black                 market. As the black market is unregulated and unlicensed, the purchasing of goods                   services may pose a health and safety risk.

3.      Falling Quality of Goods - As producers are not allowed to sell goods at a price higher                  than the maximum price. they may try to lower the production costs to increase profit or            cover costs. The quality of goods may be reduced.

4.    Consumers might gain or looseConsumers who are able to buy at the lower price of                  course are the winners. Since price ceilings notoriously cause shortages, some (those who            show up late) find that the supply has all been bought and so they loose.

 5.     Loss in Social Welfare - The distortion in people being able to purchase or sell goods                    goods reduces producer and consumer surplus by the shaded (DWL = Dead Weight Loss)          amount in the picture below.

Ok let's get to the Problems -

2005 AP Microeconomics Exam

Answer (C) There will be a shortage. 

Reffonomics - Practice makes perfect -

Welker - Price floors and ceilings  - always watch Welker!!
Determining the Effects of Price Ceilings and Price Floors

Milton Friedman on Price Controls

Podcast - Mike Munger - Price Gouging

Mike Munger Article - Price Gouging

Venezuelans snap up cheap electronic goods after government forces stores to lower prices - Video