Chapter 4Chapter 4I. Black Markets and the Importance of the Legal Structurei. Exchanges at prices outside of the range set by the Gov. (when price controls are in place) are illegalii. Controlling prices and making a good/service illegal doesn’t eliminate market forces1. Actually are created in spite of the restrictions2. Created to avoid taxesiii. Black Markets- a market that operates outside the legal system in which either illegal goods are sold or legal goods are sold at illegal prices/terms1. Enforcement of contracts and the dependability of quality will be less certain2. Greater risks- for suppliers3. No legal channels for peaceful settlement of disputes4. Violence is often used to settle disputes a. Sometimes associated with crimes gone badb. Or competition among dealersiv. A legal system that provides for secure private-property rights, contract enforcement and access to an unbiased court system for settling disputes is vitally important for the smooth operation of marketsII. The Impact of the Taxi. Tax Incidence: the way the burden of a tax is distributed among economic units 1. How shared between buyers (who pay more for what they purchased) and sellers (who receive less for what they sell)ii. Statutory Incidence: the legal assignment of a tax1. Where the government says who (buyer/seller) pays the tax2. When a tax is imposed statutorily on the seller, the supply curve shifts upward (The price will go up and quantity will godown)iii. Actual Incidence- could be felt elsewhere1. Example: a tax could be statutory placed on a seller, and in return the seller raises the prices to make up for paying the tax, in this case the buyer feels the burden of the tax.iv. Tax base: the level or quantity of an economic activity that is taxed1. Higher tax rates reduce the level of tax base because they make the activity less attractive. v. Tax Rate: the per-unit amount of the tax or the percentage rate at which the economic activity is taxedb. The Deadweight Loss caused by Taxesi. Trade results in mutual gains for buyers and sellers1. The difference in quantity exchanged is the loss of the mutual benefit.ii. Deadweight Loss or Excess Burden of Taxation: The loss of gains from trade to buyers and sellers that occurs when a tax is imposed1. A burden imposed on buyers and sellers over and above the cost of the revenue transferred to the government. 2. Excess Burden of Taxation is a reflection of the losses that occur when beneficial activities are forgone because they are taxed.3. Deadweight loss to sellers includes an indirect cost imposed on the people who supply resources to that industryc. Actual Vs. Statutory Incidencei. Economic analysis indicates that the actual burden of a tax- the split of the burden between buyers and sellers- does not dependon whether the tax is statutorily placed on the buyer or the seller.ii. How market will respond to a statutorily tax placed on buyers1. Buyers will have to pay an extra amount to the government after paying for the price of the good.2. Imposing a tax on buyers will shift the demand curve downward by the amount of the taxa. The height of the demand curve represents the MAX. the buyer is willing to payi. Purchase price + tax = total cost b. Sellers will be forced to lower the price because the demand is much loweriii. The revenue derived by the government, the number of sales eliminated by the tax and the size of the deadweight loss are IDENTICAL whether the law requires payment of the tax by sellers or buyersd. Elasticity and the Incidence of a Taxi. The incidence of a tax depends on the responsiveness of buyers and sellers to the change in price.ii. The burden of the a tax- it incidence- tends to fall more heavily on whichever side of the market has the least attractive options elsewhere1. The side of the market that is less sensitive to price changes.iii. Inelastic demand/supply curves are steeper less responsiveness to a change in priceiv. Elastic demand/supply curves are flatter a higher responsiveness to a change in pricev. When demand is relatively inelastic or supply is relatively elastic, BUYERS will bear the larger share of the tax burden. vi. When demand is relatively elastic or supply is relatively inelastic, SELLERS will bear the larger share of the tax burden. e. Elasticity and the Deadweight Lossi. Elasticity’s influence the size of the deadweight loss caused by the tax because they determine the total reduction in the quantity exchangedDemand/Supply Inelastic fewer tradesDeadweight loss smallerDemand/Supply elastic more tradesDeadweight loss largerIII. Tax Rates, Tax Revenues, and the Laffer Curvea. Average Tax Rate: tax liability divides by taxable income. i.ATR=TaxlibabilityTaxable incomeii. The percentage of income paid in taxesb. Progressive (income tax) tax: a tax in which the average tax rate rises withincomei.Type equation here .ii. People with higher incomes will pay a higher percentage of their income in taxesc. Proportional tax: a tax in which the average tax rate is the same at all income levelsi. Everyone pays the same percentage, but the amount will vary based on the incomed. Regressive tax: a tax in which the average tax rate falls with income. i. people with higher incomes will pay a lower percentage of their income in taxesii. Example: If someone is making 100k per year and #30k in tax (ATR of 30%) while someone else is making $30k and paid $15k in taxes (ATR of 50%)iii. The percentage paid in taxes declines with incomee. Marginal Tax Rate (MTR): the additional tax liability a person faces i.MTR=Change∈tax liabilityChange∈taxable incomeii. Determines how much of an additional dollar of income must be paidin taxesiii. Relevant in personal decision makingiv. Example: MTR is 25%, $25 of every $100 of additional earnings mustbe paid in taxes. Only allowed to keep $75 of earningsv. Affects the incentive to earn additional income f. When an activity is taxed heavily, people will choose to do less of it.g. Laffer Curve: A curve illustrating the relationships between the tax rate andtax revenuesi. Beyond some point, higher tax rates will shrink the tax base so much that revenue will eventually decline a tax rates are pushed to higher and higher levelsii. Higher tax rates ≠ more revenueiii. When tax rates are already high, a rate reduction may increase tax revenues. Increasing high tax rates may lead to less revenue.IV. The Impact of a Subsidya. Subsidy: a payment the government
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