HCA 586 Lecture 3

prices

• the price mechanism refers to how the free market forces of demand and supply interact to allocate scarce resources to producing goods and services

prices and the free market

• when a demand for a good and services increases, the prices for that good and service will eventually rise

• Suppliers will respond to higher prices by increasing the quantity of services they provide

  • However, the demand for items or services will decrease at higher prices until a natural, free market price is reached

  • In the presence of price controls, prices are not allowed to reach the free market price

taxation

• a means by which governments finance their expenditures, which is accomplished by imposing taxes on citizens and corporate entities

  • it is also used to encourage or discourage certain economic decisons

price controls

• regulations which restrict how high or low the price of a good or service can move

  • when regulators place controls on prices, they assume that the demand for service and the supply of the service will not change

  • they assume that the demand and supply of the service is inelastic

  • however, this is not true and as a result, the control price will not longer be an equilibrium price

  • once the control has been moved away from the equilibrium price, there are inefficiencies/waste in the system

• this occurrence can lead to shortages (with the use of price ceilings) and surpluses (with the use of price floors)

• taxes and the use of price controls also lead to deadweight loss

deadweight loss

• a failure of economic efficiency that can occur when equilibrium for a good or service cannot be attained

• larger when demand is elastic

price ceiling

• a legally maximum price set below the normal market equilibrium-prevents prices from rising too high

• the effect of the lower price for some consumers is to encourage more consumption

• price controls lead to persistent shortages, the amount that consumers want to buy the regulated price exceed what producers are willing to sell

price floor

• a legally mandated minimum price set above the normal market equilibrium-prevents prices from falling too low

• leads to persistent surpluses, the amount that producers want to sell at the regulated price exceeds the amount consumers want to buy

direct taxes

• those imposed on individuals and firms at the point at which they earn income

  • for individuals, these taxes are commonly called “income tax”

  • for firms, direct taxes are those imposed on “net “ incomes, and are variously called business tax, company tax, corporate tax, or corporation tax

indirect taxes

• those that are paid when individuals or firms make purchases, such as sales taxes and value added tax

• with a value added tax model, taxes are passed along the chain until the final consumer pays a price which includes the VAT

incidence of a tax

• the government uses taxes to generate revenue and, in some circumstances, to discourage use

• in terms of the surplus, when a tax is imposed both consumers and producers are affected

• this occurs because taxes decrease both the consumer and the producer surpluses

taxes are useful if they are:

• efficient

• convenient

• certain

• fair

• promote welfare

• maximize government revenue

• macroeconomic policy and taxes

• redistribution and taxes

efficient

• focuses on how easy they would be to collect the tax

• generally, the collection of direct taxes is made expedient through systems which reduce collection costs

• ex. payroll taxes are automatically calculated by firms using software

convenient

• taxpayers should not be required to make undue effort or take up excessive time to make tax payments

• for direct taxes, self-assessment schemes make it relatively straightforward for individuals to calculate their tax due, and online payments systems make paying tax relatively convenient

certain

• taxpayers should know in advance how much tax they will have to pay, and taxes should not be set in an arbitrary way

fair

• the concept of fairness focuses on the ability of taxpayers to pay

• a good tax system should not impose an unfair burden on one section of society and taxes should, therefore, be equitable in their impact

promote welfare

• taxes should be capable of encouraging wanted behavior and discouraging unwanted behavior, such as using sin taxes to reduce cigarette smoking and alcohol consumption, or to reduce pollution, or conserve non-renewable scarce resources, etc

maximize governmental revenue

• taxes should not encourage individuals to avoid or evade direct taxes, or to reduce their effort or supply of labor by creating a disincentive to work

  • similarly, in terms of direct indirect taxes, governments should consider the significance of price elasticity of demand for products to avoid a tax having an excessively negative impact on sales, revenue to firms, and of course, revenue to itself

macroeconomic policy and taxes

taxes can be used, along with government spending, to stimulate or constrain aggregate demand, or improve supply-side performance

redistribution and taxes

• taxes should help redistribute income or wealth between different groups, with the aim of reducing inequality

externalities

• the sale/purchase of goods/services by buyers and sellers often affects people who are not directly involved in the direct relationship with the buyer and seller

• when a spillover positively affects society, it is viewed as an external benefit or positive externality

  • ex. neighbors of an individual who got a flu shot may benefit from a reduced risk of flu regardless of whether they too got a flu shot

• when society is affected in a negative way by a spillover effect, the effect is viewed as an external cost of negative externality

  • ex. activities that cause pollution impose health and cleanup costs on the whole society regardless of the pollution’s cause

positive externality

• benefit society

• ex. K-12 education

• society cannot afford to provide this service at the natural market rate, however, if the price is lowered or capped, suppliers will reduce the supply of K-12 education

• the government will need to intervene to lower cost and increase the quantity supplied of this very important service

negative externality

• have the potential to harm society

• ex. cigarette smoke

• the market price for the product is too low, however, if the price of the cigarettes are raised, then suppliers will have the incentive to supply more and eventually the market price will fall further

• to benefit society, the government feels that is needs to discourage the consumption of cigarettes

• as a result, the government will use regulations and taxes to increase the cost to consumers and decrease the quantity supplied

gross national product

• the market value of all final goods and services produced in a nation in a single year inside and outside of the borders

  • goods and services produced outside a nation’s border by its citizens and firms are included in GNP

  • ex. GM plant located in China is included in GNP, but not GDP

gross domestic product

• the market value of all final goods and services produced domestically in a single year

  • viewed as the single most important measure of macroeconomic performance

• goods and services produced within a nation’s boundaries by foreign citizens and firms are included in GDP but excluded from GNP

  • ex. Nissan factory in TN

measuring GDP

• expenditure approach

• income approach

expenditure approach

• add up the final value on all domestic expenditures made on final goods and services (consumption expenditures, investment expenditures, government expenditures, net exports)

• final goods and services are goods and services that have been purchased for use

• these are goods that will not be resold or used in production within the next year

types of expenditures

• consumption

• investment

• government

consumption expenditures

• include purchases of nondurable goods and services (ex. food and clothing) and purchase of durable goods (ex. appliances, cars)

• they represent the largest share of total expenditures

investment expenditures

• two categories

  • fixed investment goods

    • goods that are useful over a long period of time

  • inventory goods

    • final goods waiting to be sold that firms have on hand at the end of the year

government expenditures

• the hiring of civil servants and military personnel, the construction of roads and public buildings

net exports

goods and services that are produced domestically and sold to foreigners

nominal GDP

• GDP that is evaluated at current market prices

• includes the changes in all of the market prices that have occurred during the current year due to inflation or deflation

• does not control for the effects of inflation/deflation

inflation

a rise in the overall price level

deflation

a decline in the overall price level

real GDP

• used when trying to compare changes in the overall price level over time

  • controls for the effects of inflation/deflation

  • indicator which is used to compare prices over time

  • ex. it identifies that the cost of healthcare has increased significantly over the past 10 years

unemployment

• measures the % of the total civilian labor force that are currently unemployed

• unemployment rate=the number of unemployed people/number of people in the civilian labor force

• an unemployed worker must be actively searching for work during the past month

civilian labor force

civilians 16 yo or older who are willing to work and are not incarcerated

unemployed person

a member of the civilian workforce who is currently available for work and who has worked less than 1 hour per week for pay or profit

discouraged workers

• workers who are not actively searching for work during the past month

• they are not considered as part of the civilian work force and are not counted among the unemployed

frictional unemployment

• used to describe unemployment that results from difficulties in matching qualified workers with new jobs

  • many qualified workers seeking work are not able to find new jobs right away

  • occurs because of a lack of complete info about new job openings

  • ex. regent college graduates or people who relocated

structural unemployment

• results from structural changes in the economy that cause workers to lose their jobs

  • structural changes also prevent these workers from obtaining new jobs

  • they are not qualified for the new job openings that are available, mainly because they lack the education or training needed

  • they tend to be out of work for long periods of time

  • they must learn the skills necessary for the new job or they might have to relocate

underemployment

• part time workers who want full-time work but have had to settle

• marginally attached workers who want and are available for a job, but are not actively looking

• individuals who want full time work, but can’t find or have given up looking

stagflation

• occurs when both the inflation rate and the unemployment rate are high

  • it is a difficult economic condition

  • no macroeconomic policy can address both of these problems at the same time

misery index

• the unemployment rate added to the inflation rate

• it is assumed that both a higher rate of unemployment and a worsening of inflation can create economic and social costs for a country