Chapter 5 Flashcards
What is…
equity?
efficiency?
- allocating resources fairly
- increasing social surplus
What are Price controls?
1.
2.
- are usually enacted when policymakers believe the market price is unfair to buyers or sellers
- price controls result in government-created price ceiling and price floor
What is….
- price ceiling?
- price floor?
- price ceiling is a legal maximum on the price at which a good can be sold; can be not binding (if set above the equilibrium price) and binding (set below the equilibirum price which leads to a shortage)
- a price floor is a legal minimum on the price ar which a good can be sold, e.g. minimum wage
Price Ceilings: What are some unintended consequences of rent controls?
1.
2.
3.
4.
5.
6.
7.
- a lower price attract more potential tenants (Mieter)
- a lower price scares off some potential landlords
- some appartements are converted to condos (=EIgentumswohnung), office space or storage space - in order to earn a higher return
- fewer app. buildings are contructed - which prolongs the shortage
- With less incentive to respond to customers, landlords cut maintenance costs; we would expect them to be less attentive when things break down
- Landlords try to collect shortfall in clever ways, such as furniture rental fees (“The apartment is rent controlled, but you are required to rent this folding chair for a mere
€200 a month!”) - Turnover and vacancies are lower because the opportunity costs of moving are so high! Once a family moves into a rent controlled apartment, it rarely leaves
What is the deadweight loss?
- It is the loss of economic efficiency in terms of utility for consumers/producers such that the optimal or allocative efficiency is not achieved
- the loss of total welfare or the social surplus due to reasons like taxes or subsidies, price ceilings or floors, externalities
What are Taxes?
1.
2.
3.
4.
5.
- governments levy (=erheben) taxes to raise revenue for public projects
- BUT they discourage market activity
- when a good is taxed, the quantity sold is smaller
- buyers and sellers share the tax burden
- direct and indirect tax
What are….
direct taxes?
indirect taxes? (specific and ad valorem tax)
- direct tax is livied on income and wealth
- indirect tax is levied on the sale of goods and services (specific is set amount per unit of expenditure, e.g. 0.75 per litre of petrol - ad valorem tax is expressed as a percentage)
What is Tax incidence?
- the manner in which the burden of a tax is shared among participants in a market
What is a subsidy?
- opposite to a tax
- a payment to buyers and sellers to supplement income or lower costs and which thus encourages consumption or provides an advantage to the recipient
- subsidies alter the incentives for people to trvael on the train rather than on the roads (reduces congestion and pollution)
- promotes consumption of a very specific good of which there is currently too little production
Example of a subsidy - Railway companies
- a subsidy given to railway companies shifts the supply curve outwards and lowers the price to buyers and so increases the amount purchased
- both buyers and suppliers ahre the benefit of the subsidy
- there are costs associated with subsidies
What does a low price elasticity of demand imply?
- it shows that buyers do not have good alternatives to consuming the product
What does a low price elasticity of demand imply?
- it shows that buyers do not have good alternatives to consuming the product
A tax on a product means…
1.
2.
3.
- the price that a buyer pays will be greater than the price the seller receives
- therefore, there is a tax wedge between the two prices
- the quantity sold will be smaller if there was no tax
low price elasticity means…
…that the sellers/ buyers do not have good alternatives of producing/ consuming - kurve ist STEIL wenn wenig elastisch
How to calculate the Tax Revenue?
T (Tax) x Q (Quantity)
How does a tax effect welfare?
1.
2.
3.
4.
5.
The change in total welfare includes:
- change in consumer surplus
- change in producer surplus
- change in tax revenue
- losses to buyers and sellers exceed the revenue raised by the government
- this fall in total surplus is called the deadweight loss (!)
When the supply is relatively price inelastic, (not price elastic) the deadweight loss….
…of a tax is small
When supply is relatively price elastic, the deadweight loss…
… of a tax is large
What is the Laffer Curve?
1.
2.
3.
4.
- it depicts the relationship between tax rates and tax revenue
- for the small tax, tax revenue is small
- as the size of the tax revenue grows
- but as the size of the tax continues to rise, tax revenue falls because the higher tax reduces the size of the market
When the government levies a tax on a good…
… the equilibrium quantity of the good falls
The incidence of a tax refers to….
… who bears the burden of a tax
The incidence of a tax depends on…
… the price elasticities of supply and demand.
The burden tends to fall on the side of the market that is…
… less price elastic.
The incidende of a tax does not depend on…
…whether the tax is levied on buyers or sellers.
All else being equal, the steeper (steiler) the demand curve, the …. the social surplus in a market
larger
All else being equal, the flatter the supply curve, the …. the social surplus in a market
smaller
If a supply curve is perfectly inelastic, consumer surplus… by a price ceiling.
Even if demand is perfectly elastic and supply relatively inelastic, customers achieve an overall…. in consumer surplus.
is increased
increase
If the demand curve is inelastic, price regulations can lead to…… since consumers who are willing to pay a higher price are unable to purchase the price regulated good or service in question. The….. is greater than the transfer of producer surplus to consumers.
a net loss of consumer surplus
The real cause of the welfare loss is…
… the divergence between marginal utility and marginal cost (the supply function indicates marginal cost)
Production should be expaned when marginal social costs are…
…below marginal social utility
How do subsiides affect market equilibira?
1.
2.
3.
- subsidies are usually granted to the sellers of a good
- cause production costs to fall (unlike a tax, which increases production costs)
- causes a change in the market equilibrium
If the social planner intervenes in the quantities….
… in the case of underproduction it leads to…
… in case of overproduction it leads to…
… a loss of welfare
… no euilibrium, unless the state pays a subsidy - also welfare loss
