Econ - Chapter 6

Statutory Burden: The burden of being assigned by the government to send a

tax payment.

Economic Burden: The burden created by the change in the

after-tax prices faced by buyers and sellers.

Tax Incidence: The division of the economic burden of a

tax between buyers and sellers.

Spoiler: The tax incidence does NOT depend on the

statutory burden.

The economic burden of a tax levied on sellers

may or may not fully fall upon sellers.

The economic burden of a tax levied on consumers

may or may not fully fall upon consumers.

The more inelastic your curve, the

more of the tax burden you will bear:

If sellers are relatively more inelastic, then sellers will ultimately

pay more of the tax

If buyers are relatively more inelastic, then

buyers will ultimately pay more of the tax.

Main Take-away: It doesn't matter whether the government puts the tax on the buyers or the sellers; the end result is

exactly the same!

the side that has lower elasticity will always end up

paying more tax

This $0.20 tax on buyers reduces the marginal benefits of buying a soft drink by $0.20.

The demand curve is the marginal benefit curve,

⮚if marginal benefits are $0.20 lower...

then the demand curve must shift

$0.20 down.

Both buyers and sellers bear the economic burden of the tax (even though the

statutory burden was only on buyers).

Buyers now pay $0.15 more per soft drink because of the tax.

⮚Buyers are paying $0.15 of the $0.20 tax in the form of a price increase.

Tax incidence on buyers is

75%

Sellers now receive $0.05 less per soda because of the tax.

⮚Sellers are paying $0.05 of the $0.20 tax.

Tax incidence on sellers is

25%.

The new equilibrium is found where the

demand and new supply curves intersect.

The new price buyers pay is NOT the same as the new price

sellers receive:

The two prices are different because the government takes a

0.20 cut from every sale.

ex. buyer pays more tax, so

D is less elastic

The tax incidence is determined by the

relative price elasticities of supply and demand.

Because buyers were relatively less responsive to price changes (i.e., more inelastic), the buyers ultimately bore

more of the tax incidence:

Suppose the same $0.20 tax was imposed on sellers, but this time demand is even more inelastic (i.e., even steeper). Sellers have a

small share of the economic burden, 25%, because they are much more elastic compared to buyers.

Four-step recipe for evaluating taxes: 1) Which curve is

shifting: supply, demand, or both?

Four-step recipe for evaluating taxes: 2) Is it an

an increase or a decrease in taxes?

Four-step recipe for evaluating taxes: 3) Compare the pre-tax and post-tax

equilibriums

Four-step recipe for evaluating taxes: 4) Who is more

inelastic, buyers or sellers (demand or supply)?

Increases in tax will shift the curve to the

left.

Decreases in tax will shift the curve to the

right.

Subsidy: A payment made by the

government to those who make a specific choice

A subsidy is a negative tax. The subsidy operates just like a tax, but with the

opposite sign.

Subsidies increase the

⮚quantities demanded and supplied (rather than decrease, as we saw with a tax).

Subsidies lower the price to buyers and increase the

price sellers receive (this is the opposite of what a tax does to prices).

Assessing the impact of a subsidy: Use the same four-step recipe used to analyze a tax:

1.Which curve is shifting? To whom does the policy state the subsidy is granted, demanders or suppliers?

2.Increase or decrease? Did the marginal cost (or marginal benefit) increase or decrease as a result of the subsidy?

3.How will prices and quantities change in the new equilibrium? Compare the pre- and post-subsidy outcomes.

4.Is demand or supply relatively more elastic? Who gains the greater benefit of the subsidy?

The economic benefit of the subsidy is determined by the

relatively price elasticities of the demand and supply curves.

The more inelastic party captures more

of the benefits of the subsidy.

Price Ceilings: A maximum price that sellers

can charge.

Price Ceilings: A maximum price that sellers can charge.

Specifically, it is a maximum price set by the

government.

⮚makes it illegal to exchange goods or services for prices above the established maximum price.

Binding Price Ceilings: A price ceiling that prevents the market from reaching the

market equilibrium price.

⮚A binding price ceiling must be set BELOW the equilibrium price.

For PC to be effective (binding), it has to be set below

eg'm P

The price ceiling leads to a

a shortage

⮚Suppliers are willing to supply 500 doses at this price.

Consumers demand 2,000 doses at this price

⮚A price ceiling can discourage or delay pharmaceutical companies from entering or expanding into Canadian markets.

The more elastic their supply curve, the more

⮚companies will reduce supply.

⮚The more the elastic the market's demand curve, the greater the shortage created.

Price Floors: A minimum

price that sellers can charge.

Specifically, it is a minimum price set by the

government

Price Floors: makes it illegal to exchange goods or services for prices

below the established maximum price.

Binding Price Floor: A price ceiling that prevents the market from reaching the

market equilibrium price.

⮚A binding price floor must be set ABOVE the equilibrium price.

Binding price ceilings go

⮚BELOW the market equilibrium price.

Binding price floors go

⮚ABOVE the market equilibrium price.

Quantity Regulation: A minimum or maximum

that can be sold.

Mandate: A requirement to buy or sell a

minimum amount of a good.

Quota: A limit on the

maximum quantity of a good that can be bought or sold.

Example: A health insurance mandate requires consumers to

purchase health insurance.

Example: A housing mandate requires developers to build (hence, supply) a certain amount of

⮚low-income housing.

Quota Example: Many states that have legalized marijuana limit the amount that

people can buy per day.

Binding quantity regulations only impact

market outcomes when they are binding.

Binding Mandate: The mandate needs to be placed at a quantity that is greater than the

equilibrium quantity.

Binding Mandate: It increases the

⮚quantity bought or sold to the mandated amount.

Binding Quota: The quota needs to be set at a quantity that is

less than the equilibrium quantity.

Binding Quota: It decreases the

quantity bought or sold to the amount specified by the quota.

when we have diseg'm: Qe will be the

lesser of Qs or Qd

Binding mandate: Pf>Pe,

Qe = Qd

Binding Quota: Pc < Pe,

Qe = Qs

Compare price and quantity regulations: First, figure out if the regulation is

binding or not:

Not binding 🡪 no effect on

⮚market outcomes.

Binding 🡪 determine the

new price and quantity.

Price Regulations:

New price is the

⮚regulated price.

⮚Find the quantity that corresponds to that price.

- Minimum between quantity supplied and quantity demanded.

Quantity Regulations:

New quantity is the

⮚regulated quantity.

Find the price that corresponds to that price

Quota on sellers: Price is determined by what

buyers are willing to pay for the limited quantity available

Quota on buyers: Price at which suppliers are willing to supply the

restricted quantity that buyers demand.

Compare price and quantity regulations: