Ch 4 I The Link Between Resources and Product Markets 1 The production process generally involves a the purchase of resources b transformation of the resources into products c sales of the goods and services in a product market 2 Resource Market the market for input used to produce goods and services 3 When the price of a resource such as labor changes the price of goods and services produced with that resource will change in the same direction 4 When the demand for a product changes the demand for and prices of the resources used to produce it will change in the same direction II The Economics of Price Control 1 Price Controls government mandated prices that are generally imposed in the form of maximum or minimum legal prices A The Impact of Price Ceilings 1 Shortage A condition in which the amount of a good offered for sale by produces is less than the amount demanded by buyers at the existing price 2 There are two ways that sellers can raise prices a they can raise their money price holding quality constant b they can hold the money price constant while reducing the quality of the good 3 Shortage is not the same as scarcity Scarcity is inescapable 4 Shortages are a result of prices being set below their equilibrium values a situation that is avoidable if prices are permitted to rise B Rent Control A Closer Look at a Price Ceiling 1 Rent controls are a price ceiling intended to protect residents from high housing prices 2 Rent controls will lead to the following a shortages and black markets will develop b the future supply of rental houses will decline c the quality of rental houses will deteriorate d nonprice methods of rationing will become more important e inefficient use of housing space will result C The Impact of Price Floors 1 Surplus A condition in which the amount of a good offered for sale by producers is greater than the amount that buyers will purchase at the existing price D Minimum Wage A Closer Look at a Price Floor 1 Minimum Wage Legislation requiring that workers be paid at least the stated minimum hourly rate of pay 2 Economic analysis indicates that minimum wage legislation will lead to high unemployment rates among low skilled workers III Black Markets and the Importance of the Legal Structure 1 Black Market A market that operates outside the legal system in which either illegal goods are sold or legal goods are sold at illegal prices or terms 2 A legal system that provides for secure private property rights contract enforcement and access to an unbiased court system for settling disputes as virtually important for the smooth operation markets IV The Impact of a Tax 1 Tax Incidence The way the burden of a tax is distributed among economic units The actual tax burden does not always fall on those who are statutorily assigned to pay the tax 2 Tax Base the level or quantity of an economic activity that is taxed Higher tax rates reduce the level of the tax base because they make the activity less attractive 3 Tax Rate the per unit amount of tax or the percentage rate at which the economic activity is taxed A The Deadweight Loss Caused by Taxes 1 Deadweight Loss the loss of gains from trade to buyers and sellers that occurs when a tax is imposed 2 Excess Burden of Taxation Another term for deadweight loss It reflects losses that occur when beneficial activities are forgone because they are taxed B Actual Versus Statutory Incidence 1 Economical analysis indicates that the actual burden of a tax or more precisely the split of the burden between buyers and sellers does not depend on weather the tax is statutory placed on the buyer or seller C Elasticity and the Incidence of a Tax 1 The incidence of a tax depends on the responsiveness of buyers and to a change in price 2 Progressive Tax A tax in which the average tax rate rises with income People with high incomes will pay a higher percentage of their income in taxes 3 Proportional Tax A tax in which the average tax rate is the same at all income levels Everyone pays the same percentage of income taxes 4 Regression Tax A tax in which the average tax rate falls with income People with a higher incomes will pay a lower percentage of their income in taxes 5 Marginal Tax the additional tax liability a person faces divided by his additional taxable income It is the percentage of an extra dollar of income earned that must be paid in taxes VI The Impact of a Subsidy 6 The revenue derived from a tax is equal to the tax base multiplied by the tax rate 7 Laffer Curve The curve illustrating the relationship between the tax rate and tax revenues Tax revenues will be low at both very low and very high tax rates 8 When tax rates are already high a rate reduction may increase tax revenues Correspondingly increasing high tax rates may lead to less tax revenues 1 Subsidy A payment the government makes to either the buyer or seller usually on a per unit basis when a good or service is purchased or sold A Elasticity and the Benefit of Government Subsidy Programs 1 Economist analysis indicates that the true benefit of a subsidy will a be the same regardless of whether the subsidy is granted to the buyer or sellers in a market b will depend on the elasticity of supply and demand B The Cost of Government Subsidy Programs 1 A new subsidy granted in one market will require greater taxation in other markets Ch 5 I A Close Look at Economic Efficiency 1 Economic Efficiency a situation that occurs when a all activities generating more benefit then cost undertaken b no activities undertaken for which cost exceeds benefits 2 The two rules for economic efficiency a undertaking an economic action is efficient if it produces more benefits than it cost b undertaking an economic action is inefficient if it produces more cost than benefits II If It s Worth Doing It s Worth Doing Imperfectly 1 At some point the gains from doing something even better will not be worth the cost III Thinking About The Economic Role of Government 1 Two functions of government are legitimate a protecting individuals and their property against invasion by others b providing goods that cannot be easily provided through private markets A Protective Function of Government 1 The problem function of government includes maintenance of a framework of security and order an infrastructure at rules within which people can interact peacefully with one another B Productive Function of Government 1 Providing a stable monetary and financial environment IV Potential Shortcoming of the
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