Taxation Part 2 - Markets, Tax and Efficiency

Week 6

Do competitive markets allocate resources efficiently?

Yes

What government interventions result in efficiency loss?

Policy instruments such as unit tax, a unit subsidy, a price ceiling or a price floor.

What do we call demand in resource allocation in a market?

Marginal Social Benefit

What do we call supply in resource allocation in a market?

Marginal Social Cost

What happens at point E* on this graph?

Marginal Social Benefit = Marginal Social Cost

What is allocative efficiency?

In resource use, is achieved when we push the resource use to the point where the MSB of resource use is equal to MSC.

When is it good to use the productive resources?

So long as the additional benefit of resource use for society exceeds its additional cost,

What happens at the market equilibrium with the unit tax (E1) on the graph? and is it allocatively efficient?

Marginal Social Cost < Marginal Social Benefit

No

What happens at the market equilibrium with the unit subsidary (E1) on the graph? and is it allocatively efficient?

Marginal Social Benefit < Marginal Social Cost

No

What is the subsidy expenditure?

A financial assistance provided by a government to individuals, businesses, or sectors to support economic activities and encourage certain behaviors

How do you determine the shortage on this graph?

It is the space between the Q (the quantity sold and bought) of demand and the Q (the quantity sold and bought) of supply.

What happens to MSB and MSC at Q supply on a shortage graph? and are they allocatively efficient?

Marginal Supply Benefit > Marginal Supply Chain

No

How do you determine the surplus on this graph?

It is the space between the Q (the quantity sold and bought) of demand and the Q (the quantity sold and bought) of supply.

What happens to MSB and MSC at Q supply on a surplus graph? and are they allocatively efficient?

Marginal Supply Benefit > Marginal Supply Chain

No

Where do you set a floor on this graph?

Above the P*

Why is the floor set high?

So that the price is hgih, so the quantity side will produce more.

What happens when price becomes too high?

The demand will diminish so the price goes down again.

Is government intervention bad?

Not necessarily. There are pros and cons

What is the allocatively efficient?

The market equilibrium (without external activities)

What market does not allocate resources efficiently?

A competitive market with externalities.

What can restore allocative efficiency?

An introduction of corrective unit tax or subsidy.

What happens at the market equilibrium resource allocation E0?

1. MSB < MSC - Not allocatively efficient

2. P0 < P* and Q0 > Q*

What is the equation for MSC on a graph?

MSC = MPC + MEC

What happens at the market equilibrium resource allocation E0?

1. MSB > MSC - Not allocatively efficient

2. P0 < MSB

What is the equation for MSB?

MSB = MPB + MEB

What is the equation for MSC?

MSC = MPC + MEC

What is the S with tax equation?

S with tax = MPC + tax

What can a corrective tax set at £t = £MEC at Q* imposed on a negative externality generating product restore?

It can restore allocative efficiency to a competitive market with negative externalities.

What is the resulting equilibrium for this graph?

At E* where MSC = MSB

What can a corrective subsidy set at £t = £MEC at Q* for a positive externality-generating product restore?

It can restore allocative efficiency to a competitive market with positive externalities.

What is the resulting equilibrium for this graph?

At E* where MSC = MSB.

What is the D with subsidy equation?

D with subsidy = MPB + subsidy