Surpluses and Intervention
Lecture 3 2/10/2020
Spring 2020
Dr. Eric Van Dusen
Announcements
OH has been moved to Monday 11-1, Evans 458
HW 2 is due tonight!
We will be releasing HW 3 later today
Final exam time: Tuesday May 11, 2020 from 11:30-12:30, Location TBD
We encourage you to use piazza as a public resource. More on that later.
Spring 2020
Dr. Eric Van Dusen
Spring 2020
Dr. Eric Van Dusen
Your Feedback So Far
You said that the DataHub issue last week was unconstructive. Fingers crossed on no technical issues today… (please be patient and bear with us)
Spring 2020
Dr. Eric Van Dusen
Lecture 3 Outline
Spring 2020
Dr. Eric Van Dusen
Surplus
Let’s move to the textbook...
Spring 2020
Dr. Eric Van Dusen
Taxes
We will consider only taxes levied on consumption today. These are typically enforced on a state level in the US.
Typically they take a few forms:
Spring 2020
Dr. Eric Van Dusen
Why Tax? (or provide Subsidies?)
Negative externalities: true cost not reflected in the market transacted price
Positive externalities: true benefit not reflected in the market transacted price
Spring 2020
Dr. Eric Van Dusen
An aside: Piazza
Answering and posting questions is a public good with positive externalities; the market under supplies the good.
What is a public good? 2 important attributes:
To correct for positive externalities, typically the government will provide subsidies.
Hence, there will be extra credit to the top contributor on piazza
Spring 2020
Dr. Eric Van Dusen
Externalities Graphed
Negative Externality
Positive Externality
Which good is underproduced? Which good is overproduced?
Spring 2020
Dr. Eric Van Dusen
Expressing Taxes Mathematically
If the Demand Curve is given by D(Pc) = 2000 - 20Pc and a 4 dollar sales tax is implemented on the consumer, what is the new demand curve?
If the Supply Curve is given by S(Pp) = 200 + 15 Pp and a 4 dollar tax is implemented on the producer, what is the new supply curve?
D(Pc) = 2000 - 20(Pp+4) = 2000 - 20Pp - 80 = 1920 - 20Pp
S(Pp) = 200 + 15 (Pc-4) = 200 + 15Pc - 60 = 140 + 15Pc
Pp: amount received by producer
Pp+4: amount paid by consumer (Pc)
Pc-4: amount received by producer (Pp)
Pc: amount paid by consumer
Keep track of what P refers to!
Spring 2020
Dr. Eric Van Dusen
Graphing Taxes
Mathematically, a tax is a shift in the supply/demand curve due to a change in the intercept.
A tax allows us to correct for negative externalities by charging the marginal social cost curve!
Spring 2020
Dr. Eric Van Dusen
Graphing Taxes
Quantity transacted falls from Q to Q’
Pc paid by consumers
Pp received by producers
Tax = Pc - Pp
CS and PS are reduced
Deadweight loss: area of surplus that no longer exists, due to less units being transacted
Spring 2020
Dr. Eric Van Dusen
Incidence of Tax
Statutory Incidence: the side that is legally responsible for paying the tax
Economic Incidence: side that bears the burden of the tax.
We can measure who bears the burden of the tax by comparing the amount being received/paid by producers/consumers to the original price.
Statutory incidence is independent of economic incidence! i.e. a tax that is levied on consumers will have the same burden as the same tax levied on producers.
Spring 2020
Dr. Eric Van Dusen
Economic Incidence Depends on Elasticities
Inelastic Demand
Elastic Demand
If supply is more elastic, will consumers or producers bear more of the burden of the tax?
Spring 2020
Dr. Eric Van Dusen
An Example (I)
The demand for rutabagas is:
D(Pc) = 2000 − 100Pc
The supply of rutabagas is:
S(Pp) = −100 + 200Pp
What is the equilibrium price without the tax?
Spring 2020
Dr. Eric Van Dusen
An Example (I)
The demand for rutabagas is:
D(Pc) = 2000 − 100Pc
The supply of rutabagas is:
S(Pp) = −100 + 200Pp
What is the equilibrium price without the tax?
Pp = Pc = P
2000 - 100P = -100 + 200 P
P = 7
Spring 2020
Dr. Eric Van Dusen
An Example (II)
What is the equilibrium price with a per unit $2 sales tax?
Spring 2020
Dr. Eric Van Dusen
An Example (II)
What is the equilibrium price with a per unit $2 sales tax?
2000 - 100Pc = -100 + 200 Pp
2000 - 100(Pp+2) = -100 + 200Pp
Pp = 6.33
Pc = 6.33 + 2 = 8.33
Spring 2020
Dr. Eric Van Dusen
An Example (III)
What are the tax burdens on the consumer and producer?
Spring 2020
Dr. Eric Van Dusen
An Example (III)
What are the tax burdens on the consumer and producer?
Consumer: New price paid - Old price paid = 8.33 - 7 = 1.33
Producer: Old price received - New price received = 7 - 6.33 = 0.67
The consumer bears ⅔ of the total burden of the tax
Spring 2020
Dr. Eric Van Dusen
An Example (IV)
What is change in quantity transacted due to the tax?
Spring 2020
Dr. Eric Van Dusen
An Example (IV)
What is change in quantity transacted due to the tax?
Originally, Q = 2000 - 100Pc = 2000 - 100*7 = 1300
Now, Q = 2000 - 100Pc = 2000 - 100*8.33 = 1167
1300 - 1167 = 133
We can also plug in Pp into the supply equation and get the same results
Spring 2020
Dr. Eric Van Dusen
Are Consumers Aware of Taxes?
Raj Chetty, Adam Looney, and Kory Kroft (AER 2010) seek to answer this
“We find that posting tax-inclusive price tags reduces demand by 8 percent.”
In the HW, you will look into another part of their study: beer.
Spring 2020
Dr. Eric Van Dusen
Spring 2020
Dr. Eric Van Dusen
Let’s move to the lab notebook!
We will be available if you have any questions.
Spring 2020
Dr. Eric Van Dusen
World Trade vs. Autarky
Autarky: A state of economic self-sufficiency
Why is the world supply line perfectly horizontal?
What happens to: consumer surplus? Producer surplus? Total surplus?
Spring 2020
Dr. Eric Van Dusen
What are the benefits of free trade?
Spring 2020
Dr. Eric Van Dusen
Not everything is rosy with free trade...
What are some problems?
What is protectionism?
Why would countries opt to enact protectionist measures?
Spring 2020
Dr. Eric Van Dusen
Trade Regulation: Tariffs
What happens to:
Consumer surplus?
Producer surplus?
Total surplus?
Government revenue?
Imports?
Spring 2020
Dr. Eric Van Dusen
Trade Regulation: Quotas
What happens to:
Consumer surplus?
Producer surplus?
Total surplus?
Government revenue?
Imports?
Spring 2020
Dr. Eric Van Dusen
Differences between Tariffs and Quotas
Spring 2020
Dr. Eric Van Dusen
What are other protectionist measures?
Spring 2020
Dr. Eric Van Dusen