Price controls

Taxes and subsidies

• A commodity tax is a tax on goods.

  • Excise tax: a tax that is paid directly by suppliers to the government

  • Sales tax: a tax that is paid directly by consumers to the government.

• The economic incidence of a tax is independent of its legal incidence.

  • Economic incidence: the division of a tax burden according to who actually pays the tax.

  • Legal incidence: the division of a tax burden according to who is required under the law to pay the tax.

• Who pays the tax does depend on the relative elasticities of demand and supply.

  • Elastic = escape

• Commodity taxation raises revenue (for the government) and creates lost gains from trade.

  • There is less quantity exchanged.

• A subsidy is a "negative tax", where the government gives money to consumers or producers.

  • Not elastic = no entry.

  • Creates inefficient increases in trade.

Tariffs and protectionism

• Protectionism: the economic policy of restraining trade through tariffs, quotas o other regulations that burden foreign producers but not domestic producers.

  • Tariff: a tax on imports.

  • Quota: restriction on the quantity of goods that can be imported.

• A tariff has two effects that influence (reduce) welfare:

  • Domestic consumption falls: lost gains from trade.

  • Domestic production increases: wasted resources from higher-cost production.

• The revenue doesn't affect the net welfare, as it goes to the government.

• Tariffs increase prices to consumers so domestic consumption falls, which creates a deadweight loss.

  • Tariffs divert production from low-cost (world) producers to high-cost (domestic) producers and this wastes resources.

Profit and loss

• Wage, rent, and interest are three important forms of earned income in a market economy.

  • A great deal of uncertainty has been removed by this contractual agreement.

• Profit is the fourth form of earned income in a market economy.

  • It's the residual between revenues and costs.

• Unlike the wage earned, the entrepreneur seeking profits can never be sure that their efforts will be profitable.

  • The search for profit means accepting greater uncertainty.

• Monetary expenses do not capture the total costs of production.

  • The forgone wage of an entrepreneur might not appear on a ledger, but it will remain in mind and influence choices.

• Business decisions are influenced by the presence (or absence) of economic profit.

• Profits exist, and continue to exist, without being reduced to zero by competition, because of uncertainty.

• Entrepreneurs try to reorganize activity to gain profit.

  • They also take the responsibility if it is loss.

  • They are the residual claimant.

• Entrepreneurial activity is the driving force within market processes.

  • It takes three forms: arbitrage, innovation and imitation.

  • It tends to correct for errors in the market process.

• The key to an efficient market process is open entry and exit.

  • Comparative advantage can and often does change over time.

• Speculators tend to coordinate market exchanges through time.

  • They even out the flow of commodities into consumption and diminish price fluctuations over time.

Price searching

• The usual explanation for price-setting is a simple cost-plus-markup theory: business firms calculate their unit costs and add on a percentage markup.

• Marginal revenue is the additional revenue expected from an action under consideration.

  • The extra revenue from selling one more item.

• To maximize net revenue, set a price that will enable you to sell all those units, but only those units, for which marginal revenue is expected to be greater than marginal cost.

  • The rest of the units adds more to costs than to revenue, because the price has to be lowered to sell more units.

• But by setting that price, there will be some customers lost who are willing to buy.

  • Profit can be made if the owner can reduce the price only to those new customers, without reducing it to those who are willing to pay more.

• Three conditions for successful price discrimination: the seller must be able to

  • distinguish buyers with different elasticities of demand

  • prevent low-price buyers from reselling to high-price buyers

  • control resentment.

• So how do price searchers find what they’re looking for?

  • estimating the marginal cost and marginal revenue

  • determining the level of output that will enable them to sell all those units of output, and only those units for which marginal revenue is greater than marginal cost

  • setting their price or prices so that they can just manage to sell the output produced.