February 13 2012 I Economics a Price controls 1 Price ceiling 1 Rent control a Government limit on the rental price of a generic apartment b With rent control 1 Market shortage 2 Market is inefficient a Quantity demanded is greater than quantity supplied a Producers lose b Consumers who keep apartments gain 1 Some consumers lose apartments c Example a Non binding price ceiling 1 Market can still achieve equilibrium b Market is efficient 2 Price floor a Minimum wage a Market surplus 1 Unemployment 2 Consumer surplus shrinks a Firms lose surplus b Workers who keep jobs gain surplus 1 Wage increase 3 Dead weight loss a Things considered 1 Some workers lose jobs 2 Some firms no longer hire b Natural experiment 1 Card and Krueger a New Jersey 1 Control 2 Minimum wage constant b Pennsylvania 1 Treatment 2 Minimum wage increase c Found small not significant increases in unemployment in Pennsylvania b Agricultural price supports b Per unit taxes 1 Example a 50 per carton of cigarettes b 10 per carton tax 1 Price consumers pay is 55 a Consumer surplus shrinks 2 Price producers receive is 45 a Producer surplus shrinks c Tax revenue is between 45 and 55 d Market is inefficient because of dead weight loss 1 Not because of tax revenue 2 Example 3 Tax incidence a Who bears the burden of the tax b Needs to be considered when tax policy is being constructed c Example 1 Tax the rich by taxing yachts a Yachts are elastic goods 1 Producers pay most of the tax 4 When consumer demand is inelastic consumers pay most of the tax a Example 5 When consumer demand is elastic producers pay most of the tax a Example 6 When there is a perfectly inelastic demand curve consumers pay entire tax a Example c Externalities 1 If the externalities of an activity are not experienced by the decision maker then a Goods with positive externalities produce too little 1 Under produced b Goods with negative externalities produce too much 1 Over produced 2 Problem with externalities a The private costs or benefits of the economic decision maker are not the same as the a The value of the market is equal to consumer surplus plus producer surplus plus a The value of the market is equal to consumer surplus plus producer surplus minus social costs or benefits 1 Problem of incomplete markets 3 Positive externalities externality benefit 1 Value CS PS Externality benefit 4 Negative externalities externality cost 1 Value CS PS Externality cost b Example 1 Pollution a Imposes 10 per unit of paper cost on Kent 1 Market is inefficient at P1 Q1 unpriced 2 Market is efficient at P1 Q2 a P1 Q1 is the competitive outcome in the market if the externality is b Note that the optimal level of pollution might not be zero c How to make the firm s private cost externality cost reflect the social cost of its activity 1 Put a per unit tax on the polluter equal to the cost of the externality 10 a Q1 is the competitive outcome b Q2 is socially optimal d Pollution control 1 Command and control a Technology requirements 2 Emissions taxes 3 Saleable permits e Problem 1 No one owns the river d Coase Theorem 1 In absence of transactions costs it does not matter who the property right is assigned to for the incomplete market provided the property right is assigned an efficient market will result a However income differences may result 2 In practice often the government receives the property right 3 Example a Factory creates pollution 1 Pollution gets sheets dirty a Sheets experience negative externality 2 Property right is clean air e Public goods 1 A good is rival if using the good uses it up 2 A good is non rival if using the good does not use it up a Example 1 Can of pop a Example 1 Lighthouse a Example 1 Can of pop 3 A good is excludable if usage can be limited to those who pay for it 4 A good is non excludable if usage cannot be limited to those who pay for it a Any non excludable good will suffer from the public good problem 1 Factors of the public good problem a Since the good is non excludable private businesses will not provide the public b Voluntarily provision will under provide the public good due to the free rider good problem 1 Free rider problem a People often do not contribute voluntarily but instead use the good without paying 1 Free riding on the contributions of others 2 Solution to the public good problem a Government provision 1 Second best solution a Non users are also taxed for the public good 5 A pure public good is both non rival and non excludable b Example 1 Lighthouse a Example 1 Lighthouse 6 Examples a Freeway 1 Rival good a Usage slows down other people using the good 2 Non excludable good a One does not have to pay to use b Exception 1 Toll booth a One has to pay to use b School of fish 1 Rival good 2 Non excludable good 3 Common resources a Aquifer b Grassland 1 Property of everyone in town 2 The commons a Tragedy of the commons 1 Individuals overuse common resources since failure to extract the resource will result in a competitor getting it 7 Private cost and externality cost f Progressive and regressive taxation 1 A tax is progressive if the percentage of the tax increases with income a Example 1 U S Income tax 2 A tax is proportional if the percentage of the tax is constant a Also known as a flat tax 3 A tax is regressive if the percentage of the tax decreases with income a Examples 1 Sales tax 2 Gas tax a Budget share differs by wealth b Example 1 Tax is 50 2 Poor person a Income is 10 000 b Spend 2 000 on gas 1 50 tax is 1 000 2 1 000 10 000 0 10 10 of income 3 Rich person a Income is 100 000 b Spend 4 000 on gas 1 50 tax is 2 000 2 2 000 100 000 0 20 20 of income g Lump sum tax 1 A constant dollar amount regardless of income 2 Only non distortional tax 3 Incredibly regressive a Example Income Tax tax 100 000 1 000 1 10 000 1 000 10 h Firm costs 1 Total cost TC a Formula 1 Total cost Fixed cost Variable cost a TC FC VC b Fixed cost does not change with quantity c Variable cost changes with quantity 2 Short run a The period of time in which at least 1 production factor is fixed b Average total cost in the short run 1 Average total cost is U shaped 2 Example c Rules 1 P MC 2 Shutdown rule 3 p AC q d Example a Only applies if a firm has a loss 1 If the firm operates a Quantities 1 p 5 2 AC …