Government Involvement

#1-Price Controls: Floors and Ceilings#2-Subsidies#3-Excise Taxes#4-Externalities

1

#1-PRICE CONTROLSWho likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon?

2

Qo

$5

4

3

2

1

P

10 20 30 40 50 60 70 80 3

D

S

Shortage(Qd>Qs)

Maximum legal price a seller can charge for a product.Goal: Make affordable by keeping price from reaching Eq.

Gasoline

Does this policy help consumers?

Result: BLACK

MARKETSPrice Ceiling

Price Ceiling

To have an effect,

a price ceiling must be

below equilibrium

Qo

$

4

3

2

1

P

10 20 30 40 50 60 70 80 4

D

SSurplus(Qd<Qs)

Minimum legal price a seller can sell a product.Goal: Keep price high by keeping price from falling to Eq.

Corn

Does this policy help

corn producers?

Price Floor

Price Floor

To have an effect,

a price floor must be

above equilibrium

Are Price Controls Good or Bad?To be “efficient” a market must maximize

consumers and producers surplus

Q

P

D

S

Pc

Qe

CS

PS

5

Are Price Controls Good or Bad?To be “efficient” a market must maximize consumers and

producers surplus

Price FLOOR

Q

P

D

S

Pc

QeQfloor

DEADWEIGHT LOSS The Lost CS and PS.

INEFFICIENT!

CS

PS

6

Are Price Controls Good or Bad?To be “efficient” a market must maximize consumers and

producers surplus

Q

P

D

S

Pc

Qe

CS

PS

7

Are Price Controls Good or Bad?To be “efficient” a market must maximize consumers and

producers surplus

Price CEILING

Q

P

D

S

Pc

QeQceiling

DEADWEIGHT LOSS The Lost CS and PS.

INEFFICIENT!CS

PS

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#2 SubsidiesThe government just gives producers money.The goal is for them to make more of the goods that the government thinks are important.

Ex:•Agriculture (to prevent famine)•Pharmaceutical Companies•Environmentally Safe Vehicles•FAFSA

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Result of Subsidies to Corn Producers

Qo

Price of Corn

Quantity of Corn 10

SSSubsidy

Price DownQuantity Up

Everyone Wins, Right?

Pe

P1

Qe Q1

D

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#3 Excise TaxesExcise Tax = A per unit tax on producers

For every unit made, the producer must pay $NOT a Lump Sum (one time only)TaxThe goal is for them to make less of the goods that the government deems dangerous or unwanted.

Ex:•Cigarettes “sin tax”•Alcohol “sin tax”•Tariffs on imported goods•Environmentally Unsafe Products•Etc.

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Excise Taxes

Qo

$5

4

3

2

1

P

13

Supply Schedule

P Qs

$5 140

$4 120

$3 100

$2 80

$1 60 D

S

40 60 80 100 120 140

Government sets a $2 per unit tax on Cigarettes

Excise Taxes

Qo

$5

4

3

2

1

P

14

Supply Schedule

P Qs

$5 $7 140

$4 $6 120

$3 $5 100

$2 $4 80

$1 $3 60 D

S

40 60 80 100 120 140

Government sets a $2 per unit tax on Cigarettes

Excise Taxes

Qo

$5

4

3

2

1

P

15

Supply Schedule

P Qs

$5 $7 140

$4 $6 120

$3 $5 100

$2 $4 80

$1 $3 60 D

S

40 60 80 100 120 140

Tax is the vertical distance between

supply curves

STax

Excise Taxes

Qo

$5

4

3

2

1

P

16

D

S

40 60 80 100 120 140

Identify the following:

1. Price before tax2. Price

consumers pay after tax

3. Price producers get after tax

4. Total tax revenue for the government before tax

5. Total tax revenue for the government after tax

S

#4 EXTERNALITIES

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•An externality is a third-person side effect.•There are EXTERNAL benefits or external costs to someone other than the original decision maker. Why are Externalities Market Failures?•The free market fails to include external costs or external benefits.•With no government involvement there would be too much of some goods and too little of others.Example: Smoking Cigarettes.

•The free market assumes that the cost of smoking is fully paid by people who smoke.

•The government recognizes external costs and makes policies to limit smoking.

What are Externalities?

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Negative Externalities

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Situation that results in a COST for a different person other than the original decision maker.

The costs “spillover” to other people or society.Example: Zoram is a chemical company that pollutes the air when it produces its good.

•Zoram only looks at its INTERNAL costs.•The firms ignores the social cost of pollution•So, the firm’s marginal cost curve is its supply curve•When you factor in EXTERNAL costs, Zoram is producing too much of its product.

•The government recognizes this and limits production.

Negative Externalities (aka: Spillover Costs)

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Video- Whistle Tips

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P

Q

D=MSB

Supply = Marginal

Private Cost

QFree Market

22

Market for CigarettesThe marginal private cost doesn’t include the

costs to society.

P

Q

D=MSB

Supply = Marginal

Private Cost

QFree Market 23

Market for Cigarettes

Supply = Marginal

Social Cost

What will the MC/Supply look like when EXTERNAL cost are factor in?

QOptimal

P

Q

D=MSB

S=MPC

QFree Market 24

Market for Cigarettes

S =MSC

QOptimal

At QFM the MSC is greater than the MSB.

Too much is being produced

If the market produces QFM why is it a market failure?

Overallocation

P

Q

D=MSB

QFree Market 25

Market for CigarettesWhat should the government do to fix a negative

externality?

QOptimal

S=MPC

S =MSC

Solution: Tax the amount of the

externality(Per Unit Tax)

P

Q

D=MSB

QFree Market 26

Market for CigarettesWhat should the government do to fix a negative

externality?

QOptimal

S=MPC

S =MSC

Solution: Tax the amount of the

externality(Per Unit Tax)

=MPC

MSB = MSC

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Positive Externalities

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Positive Externalities (aka: Spillover Benefits)

Situations that result in a BENEFIT for someone other than the original decision maker.

The benefits “spillover” to other people or society.(EX: Flu Vaccines, Education, Home Renovation)Example: A mom decides to get a flu vaccine for her child

•Mom only looks at the INTERNAL benefits.•She ignores the social benefits of a healthier society.•So, her private marginal benefit is her demand •When you factor in EXTERNAL benefits the marginal benefit and demand would be greater.

•The government recognizes this and subsidizes flu shots.

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P

Q

D=Marginal Private Benefit

S = MSC

QFree Market 30

Market for Flu ShotsThe marginal private benefit doesn’t include

the additional benefits to society.

P

QQFM 31

What will the MB/D look like when EXTERNAL benefits are factor in?

QOptimal

D=Marginal Private Benefit

S = MSC

D=Marginal Social Benefit

Market for Flu Shots

P

Q

D=MSB

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If the market produces QFM why is it a market failure?

S = MSC

D=Marginal Social Benefit

QFM QOptimal

Market for Flu Shots

P

Q 33

Underallocation

S = MSC

D=Marginal Social Benefit

QFM QOptimal

At QFM the MSC is less than the MSB.

Too little is being produced

Market for Flu Shots

P

QQFM 34QOptimal

D=MPB

S = MSC

D=MSB

What should the government do to fix a negative externality?

Subsidize the amount of the externality (Per Unit Subsidy)

=MPB

Market for Flu Shots

Economics of PollutionWhy are public bathrooms so gross?

The Tragedy of the Commons (AKA: The Common Pool Problem)

•Goods that are available to everyone (air, oceans, lakes, public bathrooms) are often polluted since no one has the incentive to keep them clean. •There is no monetary incentive to use them efficiently.•Result is high spillover costs.Example: Over fishing in the ocean 35

Perverse Incentives1. In 1970, the government tried to protect endangered

woodpeckers by requiring land developers to report nests on their land to the EPA.

The population of these bird decreased. Why? Land owners would kill the birds or else risk lengthy production delays. (Known as “Shoot, Shovel, and Shut Up”)

2. Assume the government wanted to limit a firm from polluting. They tell them they will inspect them twice and they must reduce pollution by 5%.

The amount of pollutants would increase. Why?These firm will have the incentive to pollute more prior to

inspection.Are their “market solutions” to these

problems? 36

How can markets and self interest help to limit pollution?

Government can sell the right to pollute

100

200

5050

100

Assume the lake can naturally absorb 500 gallons of pollutants

each year

Now what does each firm have the incentive

to do?

The Gov’t sells each firm the right to

pollute a set number of gallons