Role of the gov in microeconomics (tax, subsidies, price floor/ceiling)

Name 6 reasons for government intervention

- support certain producers (eh. farmers)

- support low income households

- influence level of output

- influence level of consumption

- correct market failures

- promote equity

Define indirect tax

A tax imposed by the government on expenditure of firms, passed down to consumers to buy goods and services.

Define unit tax

A fixed indirect tax per unit of good

Define ad valorem tax

An indirect tax on the percentage of the price of a good

What does GST stand for?

Goods and services tax

What is the GST in New Zealand?

15%

How is this implemented?

Added to the price of most goods and services supplied in new Zealand

REAL WORLD EXAMPLE - FRANCE CIGARETTES TAX

€6.61 on cigarettes in 2021, compared to EU average of €3.34

Name 4 reasons why governments impose taxes

- collect tax revenues to finance gov. expenditure

- decrease consumption of demerit goods (tobacco, alcohol, sugar)

- decrease production of polluting goods/services or fossil fuels

- decrease imports to help local producers

To firms, what is an indirect tax?

Additional cost of production

As a result, what happens to supply?

Supply decreases, the supply curve shifts t the left (vertically upwards) by the amount of the tax.

What is the shift of a specific tax?

A parallel shift

What is the shift of an ad valorem tax?

Vertical distance between the two curves is larger at higher prices, the taxed supply curve is steeper

How does an indirect tax impact price consumers pay?

Price consumers pay increases

How does an indirect tax impact quantity supplied?

Qs decreases

How an indirect tax impact amount which producers earn per unit?

Producers earn less per unit

What is this amount?

Price consumers pay - tax

What is the tax revenue collected by the government?

(price consumers pay - earnings of producers) x new Qs

EFFECTS ON STAKEHOLDERS:

- How does this affect consumers?

- How does this affect producers?

- How does this affect the government?

- How does this affect society?

- Consumers are worse off because they pay a higher price (increase in price) and enjoy less of the good (decrease in Qs) - their surplus is decreased

- However, if the good is a demerit good, the lower consumption results in better health making them better off

- Producers are worse off because they earn less per unit (decrease in revenue) and sell fewer units (decrease in Qs) - their surplus is decreased

- Workers may be laid off because firms need to reduce costs of production

- If the good taxed is one that is needed in the process of making another, then this will also increase costs of production

- This forces firms to raise price and suffer a decrease in sales and employment level

- Government collects tax revenues that can be spent on the public sector, which cannot be considered a loss to society

- Producers and consumers both experience a decrease in surplus, so social surplus decreases indicating a decrease in welfare

- However, the government collects tax revenues so welfare loss is reduced

- The remaining welfare loss is the net value lost by society by the difference between new Qs and initial Qs not being produced due to the tax

Why are indirect taxes considered unfair?

Because they are regressive with respect to consumer income. The tax means that a good takes up a higher proportion of poorer consumers' income.

Is there welfare loss if the tax is imposed on a demerit good? Why?

No. Lower levels of production and consumption of demerit goods are socially optimal

What does indirect tax depend on?

PED and PES

If demand is more price inelastic than supply, how does this affect the tax?

The incidence is greater on consumers because more of the tax is passed onto them by producers

If supply is more price inelastic than demand, how does this affect the tax?

The incidence is greater on producers because if they pass the tax onto consumers the demand for their product will fall

Define subsidy

Payment by the government to firms, per unit of output, to incentivise production and provide advantage over foreign competition.

RWE SUBSIDY 1

Malaysia 1980 - rice farmers get pre-determined sum of Malaysia ringgit for each tonne of rice harvested.

RWE SUBSIDY 2

2018 - Governments worldwide payed round $35 bil. in subsidies to fishing fleets to decrease their cost of inputs

Name 5 reasons why governments provide subsidies

- To increase particular producers' revenue (usually producers of income inelastic goods like farmers - rural/urban inequality decreases - promote food self sufficiency improving nutrition among low income households)

- Decrease price of basic goods and services to make them more affordable

- Help certain industries grow (promotion of environmentally friendly technology etc.)

- Increase consumption of merit goods (education + healthcare)

- Protect domestic firms from foreign competition (import penetration)

Short analysis of subsidy's effects

A subsidy decreases production costs, as a result increasing supply. This shifts the supply curve vertically downwards by the amount of the subsidy, parallel to the origin of the initial supply curve.

How will the supply curve shift if a subsidy is given?

Vertically downwards by the amount of the subsidy

How do subsidies affect market price payed by consumers?

Market price decreases

How do subsidies affect Qs?

Qs increases

What do producers earn after the subsidy?

Price payed by consumers + subsidy

What is the cost of the subsidy to the government?

what producers earn x new Qs

CONSEQUENCES FOR STAKEHOLDERS:

How do subsidies affect consumers, producers, the government, society?

- Consumers are better off because they pay a lower price and enjoy more of the good

- Consumer surplus increases

- Producers are better off because they earn and sell more per unit

- Revenues and surplus increase

- The government needs to finance the subsidy to spends more

- To finance this they may impose taxes in the short run, borrow more in the short run and tax in the long run, or cut spending in the short run on another gov. programme

- Financing a subsidy causes opportunity cost for society

- Both consumers and producers see an increase in surplus so welfare increases

- Resource allocation improves

- However, the cost of subsidy to the government creating opportunity cost detracts from this increase in welfare, creating welfare loss

What is welfare loss of a subsidy?

The difference between new Qs and old Qs now being produced even though from society's viewpoint it does not have to be

Is there welfare loss if the subsidy is to a merit good / for improving the environment? Why?

No. Because the welfare effects of a subsidy are judged by weighing expected benefits against its cost (what society sacrifices for it)

Define price ceiling

Form of price control imposed by the government / authorities imposing a price below the market equilibrium price of a good / service which is seen as too high

What does a price ceiling act as?

The maximum price which a good / service can be sold at, which is below market price. The government restricts this price to protect consumers against unaffordable high prices

RWE PRICE CEILING

2019 - Oregon USA, set rent increase was 7%

What does a price ceiling result in in terms of Qs and Qd

Quantity supplied is less than the quantity which consumers are willing and able to buy. (Qs < Qd). This creates a shortage which is length QsQd

What are the advantages of control on rent prices?

- Make housing more affordable

- Prevent displacement of low income residents

- Decrease homelessness

What are the disadvantages of a control on rent prices?

- There is a shortage of supply

- Not all tenants who are willing and able to pay the price ceiling price will be able to rent property

- Decrease in quality of housing in the long term as producers earning less have less incentive to maintain good quality

- Number of suppliers may decrease making shortages more severe

Outline 7 non-price rationing mechanisms

- Once a shortage arises the price ceiling no longer performs its rationing function and alternative rationing mechanisms are developed

- "First come first served" Real estate agents adopt waiting lists or people rush to grocery stores and gas stations before they run out

- Firms decide who can buy their goods, may lead to discrimination

- May be random allocation of supplies

- Government adopts rationing

Outline emergence of parallel markets

Under the table payments take place / hidden markets become more prevalent - higher income individuals benefit from this, putting poorer people at a disadvantage which is counterintuitive of the price ceiling

STAKEHOLDERS OF PRICE CEILINGS

How do they affect consumers, producers, society?

- Consumer surplus decreases. Some consumers can find the product at a lower price and are better off, but they are not necessarily the low income households.

- Some consumers are worse off as they are willing and able to buy at the new price but cannot consume this porduct due to shortages

- Shortages create room for discrimination against buyers due to shortage

- Producer surplus decreases, so producers are worse off unless they sell at illegal prices and risk being caught.

- Some producers leave the market or experience long term decline in value of their good so quality and quantity decrease (further affecting consumers who enjoy less of and a worse good)

- Producers lose incentive to innovate and improve

- Social surplus decreases representing welfare loss to society

- There is now allocative inefficiency in the market

Outline gentrification

Process of reviving deteriorated urban neighbourhoods as a result of influx of wealthy residents. Demand rises therefore increasing price and goods and services are less affordable for lower income households which are displaced. So, restrictions are necessary to keep prices affordable, but should be used cautiously to ensure that long term growth is incentivised. This can be done in housing for example by placing restrictions on older blocks only. This prevents homelessness which impacts both individuals and society negatively.

Define price floor

Form of price control imposed by the government / authorities imposing a price above the market equilibrium price of a good / service which is seen as too low

What is it used for?

Acting a the lowest possible price a good can be sold for to protect certain producers (usually agricultural producers like farmers), preventing price from dropping below a certain level

Outline 3 reasons why a government would impose a price floor

- Fluctuation in prices and hence the income of producers whose products are also affected by uncontrollable weather etc. reducing supply lead to price volatility.

- As economies grow, demand for agricultural products do too but slowly, Farmers' YED for products is low so over time their income decreases relatively to income of industrial workers

- Gov. could protect employment in rural areas by preventing urbanisation (immigration from rural areas to cities for work). Cities have less pressure on infrastructure

What does a price floor result in in terms of Qs and Qd?

Price floor is above equilibrium price. Producers then offer more units than what consumers are willing and able to buy. Qs > Qd. The surplus is the distance between Qd and Qs. To avoid collapse of the price floor the government buys the surplus at the new price, artificially increasing demand (D + gov. purchase).

RWE PRICE FLOOR

Minimum wage = 1,539.42 EUR per month (Jun 2020) - France

What does the government do with the surplus?

- Release stock into the market to avoid increase in price if there is crop failure (storage has additional cost)

- Destroy the surplus (wasteful)

- Dumping (sell to foreign markets at a below average price) = disrupts trade relations and domestic farmers of the foreign country to suffer from lower abroad price

STAKEHOLDERS PRICE FLOOR

How does a price floor affect consumers, producers, the government, society?

- Consumers pay more than they otherwise would

- Enjoy less of the good

- Consumer surplus decreases

- If good is used in manufacturing then production costs increase leading to higher prices for those goods too

- Producers (farmers) - are better off due to stabilised, higher income

- Producer revenue and surplus increases

- The gov is forced to spend heavily on surplus (new P x QdQs - cd central triangle)

- Opportunity cost as financing expenditure leads to higher taxes, borrowing more, or cutting spending on other projects

- Large welfare loss to society due to overproduction and misallocation of resources

Why is a minimum wage set?

To guarantee a socially acceptable income to unskilled workers

Define minimum wage

A type of price floor where the wage rate or the price of labour is set above the market equilibrium wage rate.

What is the axis for a minimum wage diagram?

vartical: Wage rate (W)

horizontal: N˚ of workers (L)

Why is demand for labour D(L) negatively sloped?

At higher wage rates firms try to substitute capital for labour

Why is supply for labour S(L) upward sloping?

At higher wage rates opportunity cost for leisure increases (becomes more expensive for some to be out the labour market), more individuals substitute work for leisure

What are W and L when labour is competitive?

At equilibrium, We and Le

If the government considers market determined wage (We) as too low, what happens to W and L?

W increases to W' (minimum wage)

L decreases because firms want to hire less individuals due to higher costs of production. D(L) < S(L)

Excess surplus of labour (L1L2) = unemployment

What are the benefits and cons of minimum wage on workers?

- Individuals who do not lose their jobs have an increase in income to W'

- Workers who would have had a job at We rather than no job at all are worse off (L1 to Le)

Although, if minimum wage was extremely low to begin with there is less chance that unemployment will drastically increase in the face of minimum wage