ECON 100 1st Edition Lecture 10 Outline of Last Lecture I Is the Competitive Market Efficient A Efficiency of Competitive Equilibrium B The Invisible Hand C Market Failure 1 Sources of Market Failure D Alternatives to the Market 1 Ideas About Fairness II Housing Market with a Rent Ceiling A Housing Shortage Increased Search Activity Black Market B Inefficiency C Fairness Outline of Current Lecture I A Labor Market with a Minimum Wage A Unemployment B Fairness C Efficiency II Taxes A Tax Incidence 1 Elasticity of Demand 2 Elasticity of Supply B Efficiency C Fairness 1 Benefits 2 Ability to Pay III Production Quotas and Subsidies IV Market for Illegal Goods Current Lecture A Labor Market with a Minimum Wage A price floor is a regulation that makes it illegal to trade at a price lower than a specified level When a price floor is applied to labor markets it is called a minimum wage If the minimum wage is set below the equilibrium wage rate it has no effect the market works as if there were no minimum wage These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute If the minimum wage is set above the equilibrium wage rate it has powerful effects 1 Minimum Wage Brings Unemployment a If the minimum wage is set above the equilibrium wage rate the quantity of labor supplied by workers exceeds the quantity demanded by employers there is a surplus of labor b The quantity of labor hired at the minimum wage is less than the quantity that would be hired in an unregulated labor market c Because the legal wage rate cannot eliminate the surplus the minimum wage creates unemployment 2 Is Minimum Wage Fair a A minimum wage rate in the United States is set by the federal government s Fair Labor Standards Act b In 2009 the federal minimum wage rate was raised to 7 25 an hour and has remained at 7 25 an hour through 2012 c Some state governments have set minimum wages above the federal minimum wage rate d Most economists believe that minimum wage laws increase the unemployment rate of low skilled younger workers 3 Inefficiency of a Minimum Wage a The quantity of labor employed is less than the efficient quantity b The supply of labor measures the marginal social cost of labor to workers leisure forgone c The demand for labor measures the marginal social benefit from labor value of goods produced d A minimum wage set above the equilibrium wage decreases the quantity of labor employed a deadweight loss arises the potential loss from increased job search decreases both workers surplus and firms surplus Taxes Income tax and the Social Security tax are deducted from your pay and state sales tax is added to the price of the things you buy Tax Incidence Tax incidence is the division of the burden of a tax between buyers and sellers When an item is taxed its price might rise by the full amount of the tax by a lesser amount or not at all If the price rises by the full amount of the tax buyers pay the tax If the price rises by a lesser amount than the tax buyers and sellers share the burden of the tax If the price doesn t rise at all sellers pay the tax Tax incidence doesn t depend on tax law Tax Incidence and Elasticity of Demand The division of the tax between buyers and sellers depends on the elasticities of demand and supply To see how we look at two extreme cases 1 Perfectly inelastic demand Buyers pay the entire tax a Demand for this good is perfectly inelastic the demand curve is vertical b When a tax is imposed on this good buyers pay the entire tax 2 Perfectly elastic demand Sellers pay the entire tax a The demand for this good is perfectly elastic the demand curve is horizontal b When a tax is imposed on this good sellers pay the entire tax The more inelastic the demand the larger is the buyers share of the tax Tax Incidence and Elasticity of Supply To see the effect of the elasticity of supply on the division of the tax payment we again look at two extreme cases 1 Perfectly inelastic supply Sellers pay the entire tax a The supply of this good is perfectly inelastic the supply curve is vertical b When a tax is imposed on this good sellers pay the entire tax 2 Perfectly elastic supply Buyers pay the entire tax a The supply of this good is perfectly elastic the supply curve is horizontal b When a tax is imposed on this good buyers pay the entire tax The more elastic the supply the larger is the buyers share of the tax Taxes in Practice Taxes usually are levied on goods and services with an inelastic demand or an inelastic supply Alcohol tobacco and gasoline have inelastic demand so the buyers of these items pay most of the tax on them Labor has a low elasticity of supply so the seller the worker pays most of the income tax and most of the Social Security tax Taxes and Efficiency Except in the extreme cases of perfectly inelastic demand or perfectly inelastic supply when the quantity remains the same imposing a tax creates inefficiency With no tax marginal social benefit equals marginal social cost total surplus the sum of consumer surplus and producer surplus is maximized the market is efficient The tax decreases the quantity raises the buyers price and lowers the sellers price Marginal social benefit exceeds marginal social cost and the tax is inefficient the tax revenue takes part of the total surplus the decreased quantity creates a deadweight loss Taxes and Fairness Economists propose two conflicting principles of fairness to apply to a tax system 1 The benefits principle a The benefits principle is the proposition that people should pay taxes equal to the benefits they receive from the services provided by government b This arrangement is fair because it means that those who benefit most pay the most taxes 2 The ability to pay principle a The ability to pay principle is the proposition that people should pay taxes according to how easily they can bear the burden of the tax b A rich person can more easily bear the burden than a poor person can so the ability to pay principle can reinforce the benefits principle to justify high rates of income tax on high incomes Production Quotas and Subsidies Intervention in markets for farm products takes two main forms Production quotas an upper limit to the quantity of a good that may be produced during a specified period a Inefficiency At the quantity produced marginal social benefit equals the market price which has increased marginal social cost has decreased