Chapter 6

Question 1

Price ceiling (or price cap)

Answer 1

A regulation that makes it illegal to charge a price higher than a specified level.

Question 2

The effects of a price ceiling on a market depend crucially on whether the ceiling is imposed at a level that is ________________________.

Answer 2

The effects of a price ceiling on a market depend crucially on whether the ceiling is imposed at a level that is above or below the equilibrium price.

Question 3

A price ceiling set above the equilibrium price has _______.

Answer 3

A price ceiling set above the equilibrium price has no effect.

The reason is that the price ceiling does not constrain the market forces. The force of the law and the market forces are not in conflict.

Question 4

A price ceiling below the equilibrium price has ________.

Answer 4

A price ceiling below the equilibrium price has powerful effects on a market

The reason is that the price ceiling attempts to prevent the price from regulating the quantities demanded and supplied. The force of the law and the market forces are in conflict.

Question 5

Rent ceiling

Answer 5

A regulation that makes it illegal to charge a rent higher than a specified level.

Question 6

A rent ceiling set below the equilibrium rent creates: 3 things

Answer 6

A housing shortage

Increased search activity

A black market

Question 7

In a housing market, when the rent is at the equilibrium level, the ________ of ________ equals the _______ of ________ and there is neither a shortage nor a surplus of housing.

Answer 7

In a housing market, when the rent is at the equilibrium level, the quantity of housing supplied equals the quantity of housing demanded and there is neither a shortage nor a surplus of housing.

Question 8

At a rent set below the equilibrium rent, the quantity of housing demanded ________ the quantity of housing supplied—there is a shortage.

Answer 8

at a rent set below the equilibrium rent, the quantity of housing demanded exceeds the quantity of housing supplied—there is a shortage.

So if a rent ceiling is set below the equilibrium rent, there will be a shortage of housing.

Question 9

Search activity

Answer 9

The time spent looking for someone with whom to do business.

We spend some time in search activity almost every time we make a purchase. When you’re shopping for the latest hot new cellphone, and you know four stores that stock it, how do you find which store has the best deal? You spend a few minutes on the Internet, checking out the various prices. In some markets, such as the housing market, people spend a lot of time checking the alternatives available before making a choice.

Question 10

When a price is regulated and there is a shortage, search activity ________.

Answer 10

When a price is regulated and there is a shortage, search activity increases.

In the case of a rent-controlled housing market, frustrated would-be renters scan the newspapers, not only for housing ads but also for death notices! Any information about newly available housing is useful, and apartment seekers race to be first on the scene when news of a possible supplier breaks.

Question 11

the opportunity cost of housing is equal to the ________ plus ________________.

Answer 11

the opportunity cost of housing is equal to the rent (a regulated price) plus the time and other resources spent searching for the restricted quantity available

Search activity is costly. It uses time and other resources, such as phone calls, automobiles, and gasoline that could have been used in other productive ways.

Question 12

Black market

Answer 12

An illegal market in which the equilibrium price exceeds the legally imposed price ceiling.

Black markets occur in rent-controlled housing and many other markets. For example, scalpers run black markets in tickets for big sporting events and rock concerts.

Question 13

The level of a black market rent depends on how tightly the rent ceiling is enforced. With loose enforcement, the black market rent is ________ to the unregulated rent. But with ________ enforcement, the black market rent is equal to the maximum price that a renter is willing to pay.

Answer 13

The level of a black market rent depends on how tightly the rent ceiling is enforced. With loose enforcement, the black market rent is close to the unregulated rent. But with strict enforcement, the black market rent is equal to the maximum price that a renter is willing to pay.

Question 14

A rent ceiling set below the equilibrium rent results in an ________________ of housing services.

Answer 14

A rent ceiling set below the equilibrium rent results in an inefficient underproduction of housing services.

The marginal social benefit of housing exceeds its marginal social cost and a deadweight loss shrinks the producer surplus and consumer surplus

Question 15

Fig 6.2

Answer 15

Figure 6.2 shows this inefficiency. The rent ceiling ($800 per month) is below the equilibrium rent ($1,000 per month) and the quantity of housing supplied (60,000 units) is less than the efficient quantity (80,000 units).

Question 16

the full loss from the rent ceiling is the _______ of the deadweight loss and the increased cost of search.

Answer 16

the full loss from the rent ceiling is the sum of the deadweight loss and the increased cost of search.

Question 17

When the rent is not permitted to allocate scarce housing, what other mechanisms are available, and are they fair? Some possible mechanisms are:

Answer 17

A lottery

First-come, first-served

Discrimination

Question 18

A lottery allocates housing to ______________, not to those who are poor

Answer 18

A lottery allocates housing to those who are lucky, not to those who are poor

Question 19

First-come, first-served (a method used to allocate housing in England after World War II) allocates housing to those _____________, not to the poorest.

Answer 19

First-come, first-served (a method used to allocate housing in England after World War II) allocates housing to those who have the greatest foresight and who get their names on a list first, not to the poorest.

Question 20

Discrimination allocates scarce housing based on __________________.

Answer 20

Discrimination allocates scarce housing based on the views and self-interest of the owner of the housing.

Question 21

Price floor

Answer 21

A regulation that makes it illegal to trade at a price lower than a specified level.

Question 22

A price floor set below the equilibrium price has __________________

Answer 22

A price floor set below the equilibrium price has no effect

The reason is that the price floor does not constrain the market forces. The force of the law and the market forces are not in conflict.

Question 23

A price floor set above the equilibrium price has __________________

Answer 23

A price floor set above the equilibrium price has powerful effects on a market

The reason is that the price floor attempts to prevent the price from regulating the quantities demanded and supplied. The force of the law and the market forces are in conflict.

Question 24

Minimum wage

Answer 24

A regulation that makes the hiring of labour below a specified wage rate illegal. The lowest wage at which a firm may legally hire labour.

Question 25

A minimum wage imposed at a level that is above the equilibrium wage creates __________

Answer 25

A minimum wage imposed at a level that is above the equilibrium wage creates unemployment

Question 26

a wage rate above the equilibrium wage, the quantity of labour supplied _______ the quantity of labour demanded

Answer 26

a wage rate above the equilibrium wage, the quantity of labour supplied exceeds the quantity of labour demanded

there is a surplus of labour. So when a minimum wage is set above the equilibrium wage, there is a surplus of labour. The demand for labour determines the level of employment, and the surplus of labour is unemployed.

Question 27

Fig 6.3

Answer 27

Figure 6.3 illustrates the effect of the minimum wage on unemployment. The demand for labour curve is D and the supply of labour curve is S. The horizontal red line shows the minimum wage set at $10 an hour. A wage rate below this level is illegal, in the grey-shaded illegal region of the figure. At the minimum wage rate, 20 million hours of labour are demanded (point A) and 22 million hours of labour are supplied (point B), so 2 million hours of available labour are unemployed.

With only 20 million hours demanded, someone is willing to supply that 20 millionth hour for $8. Frustrated unemployed workers spend time and other resources searching for hard-to-find jobs.

Question 28

The minimum wage is _______ on both views of fairness

Answer 28

The minimum wage is unfair on both views of fairness: It delivers an unfair result and imposes an unfair rule.

Question 29

The result is _______ because only those people who have jobs and keep them benefit from the minimum wage

Answer 29

The result is unfair because only those people who have jobs and keep them benefit from the minimum wage

Question 30

The minimum wage imposes an unfair rule because it______________

Answer 30

The minimum wage imposes an unfair rule because it blocks voluntary exchange.

Firms are willing to hire more labour and people are willing to work more, but they are not permitted by the minimum wage law to do so.

Question 31

In the labour market, the supply curve measures the __________ of labour to workers.

Answer 31

In the labour market, the supply curve measures the marginal social cost of labour to workers.

This cost is leisure forgone.

Question 32

The demand curve measures the _________ from labour.

Answer 32

The demand curve measures the marginal social benefit from labour.

This benefit is the value of the goods and services produced.

Question 33

Fig 6.4

Answer 33

Figure 6.4 shows this inefficiency. The minimum wage ($10 an hour) is above the equilibrium wage ($9 an hour) and the quantity of labour demanded and employed (20 million hours) is less than the efficient quantity (21 million hours).

Question 34

When the quantity of labour employed is less than the efficient quantity, there is a _________

Answer 34

When the quantity of labour employed is less than the efficient quantity, there is a deadweight loss

Question 35

The full loss from the minimum wage is the sum of _____________________________.

Answer 35

The full loss from the minimum wage is the sum of the deadweight loss and the increased cost of job search.

Question 36

Tax incidence

Answer 36

The division of the burden of the tax between the buyer and the seller.

Question 37

When the government imposes a tax on the sale of a good, the price paid by buyers might _______ by the full amount of the tax, by a lesser amount, or not at all.

Answer 37

When the government imposes a tax on the sale of a good,* the price paid by buyers might rise by the full amount of the tax, by a lesser amount, or not at all.

Question 38

If the price paid by buyers rises by the full amount of the tax, then ___________________

Answer 38

If the price paid by buyers rises by the full amount of the tax, then the burden of the tax falls entirely on buyers—the buyers pay the tax.

Question 39

If the price paid by buyers rises by a lesser amount than the tax, then ________________

Answer 39

If the price paid by buyers rises by a lesser amount than the tax, then the burden of the tax falls partly on buyers and partly on sellers.

Question 40

if the price paid by buyers doesn’t change at all, then __________________

Answer 40

if the price paid by buyers doesn’t change at all, then the burden of the tax falls entirely on sellers.

Question 41

Tax incidence does not depend on the __________

Answer 41

Tax incidence does not depend on the tax law.

The law might impose a tax on sellers or on buyers, but the outcome is the same in either case.

Question 42

Fig 6.5

Answer 42

In Fig. 6.5, the demand curve is D and the supply curve is S. With no tax, the equilibrium price is $6 per pack and 350 million packs a year are bought and sold.

A tax on sellers is like an increase in cost, so it decreases supply. To determine the position of the new supply curve, we add the tax to the minimum price that sellers are willing to accept for each quantity sold. You can see that without the tax, sellers are willing to offer 350 million packs a year for $6 a pack. So with a $3 tax, they will offer 350 million packs a year only if the price is $9 a pack. The supply curve shifts to the red curve labelled 
S
\+
tax
 on sellers.

Equilibrium occurs where the new supply curve intersects the demand curve at 325 million packs a year. The price paid by buyers rises by $2 to $8 a pack. And the price received by sellers falls by $1 to $5 a pack. So buyers pay $2 of the tax on a pack and sellers pay the other $1.

Question 43

Fig 6.6

Answer 43

A tax on buyers lowers the amount they are willing to pay sellers, so it decreases demand and shifts the demand curve leftward. To determine the position of this new demand curve, we subtract the tax from the maximum price that buyers are willing to pay for each quantity bought. You can see, in Fig. 6.6, that without the tax, buyers are willing to buy 350 million packs a year for $6 a pack. So with a $3 tax, they are willing to buy 350 million packs a year only if the price including the tax is $6 a pack, which means that they’re willing to pay sellers only $3 a pack. The demand curve shifts to become the red curve labelled D − tax on buyers.

Equilibrium occurs where the new demand curve intersects the supply curve at a quantity of 325 million packs a year. The price received by sellers is $5 a pack, and the price paid by buyers is $8 a pack.

Question 44

When a transaction is taxed, there are two prices: the price paid by buyers, which includes the tax; and the price received by sellers, which excludes the tax. Buyers respond to the price that ________ the tax and sellers respond to the price that ________ the tax.

Answer 44

When a transaction is taxed, there are two prices: the price paid by buyers, which includes the tax; and the price received by sellers, which excludes the tax. Buyers respond to the price that includes the tax and sellers respond to the price that excludes the tax.

Question 45

Can We Share the Burden Equally?

Answer 45

Suppose that Ontario wants the burden of the cigarette tax to fall equally on buyers and sellers and declares that a $1.50 tax be imposed on each. Is the burden of the tax then shared equally?

You can see that it is not. The tax is still $3 a pack. You’ve seen that the tax has the same effect regardless of whether it is imposed on sellers or buyers. So imposing half the tax on sellers and half on buyers is like an average of the two cases you’ve just examined. (Draw the demand-supply graph and work out what happens in this case. The demand curve shifts downward by $1.50 and the supply curve shifts upward by $1.50. The new equilibrium quantity is still 325 million packs a year. Buyers pay $8 a pack, of which $1.50 is tax. Sellers receive $6.50 from buyers, but pay a $1.50 tax, so sellers net $5 a pack.)

Question 46

The Employment Insurance tax is an example of a tax that the federal government imposes on _________________.

Answer 46

The Employment Insurance tax is an example of a tax that the federal government imposes on both workers (buyers) and firms (sellers).

Question 47

Does the market for labour decide or the federal government decide how the burn of the Employment Insurance tax is divided between firms and workers?

Answer 47

The market for labour, not the federal government, decides how the burden of the Employment Insurance tax is divided between firms and workers.

Question 48

The division of the tax between buyers and sellers depends in part on the elasticity of demand. There are two extreme cases:

Answer 48

Perfectly inelastic demand—buyers pay.

Perfectly elastic demand—sellers pay.

Question 49

Fig 6.7

Answer 49

Figure 6.7 shows the market for insulin, a vital daily medication for those with diabetes. Demand is perfectly inelastic at 100,000 doses a day, regardless of the price, as shown by the vertical demand curve D. That is, a diabetic would sacrifice all other goods and services rather than not consume the insulin dose that provides good health. The supply curve of insulin is S. With no tax, the price is $2 a dose and the quantity is 100,000 doses a day.

If insulin is taxed at 20¢ a dose, we must add the tax to the minimum price at which drug companies are willing to sell insulin. The result is the new supply curve S+tax. The price rises to $2.20 a dose, but the quantity does not change. Buyers pay the entire tax of 20¢ a dose.

Question 50

Fig 6.8

Answer 50

Figure 6.8 shows the market for pink marker pens. Demand is perfectly elastic at $1 a pen, as shown by the horizontal demand curve D. If pink pens are less expensive than the other colours, everyone uses pink. If pink pens are more expensive than other colours, no one uses pink. The supply curve is S. With no tax, the price of a pink pen is $1 and the quantity is 4,000 pens a week.

Suppose that the government imposes a tax of 10¢ a pen on pink marker pens but not on other colours. The new supply curve is S+tax. The price remains at $1 a pen, and the quantity decreases to 1,000 pink pens a week. The 10¢ tax leaves the price paid by buyers unchanged but lowers the amount received by sellers by the full amount of the tax. Sellers pay the entire tax of 10¢ a pink pen.

Question 51

In the usual case, demand is neither perfectly inelastic nor perfectly elastic and the tax is ______________

Answer 51

In the usual case, demand is neither perfectly inelastic nor perfectly elastic and the tax is split between buyers and sellers.

Question 52

The division of the tax between buyers and sellers also depends, in part, on the elasticity of supply. Again, there are two extreme cases:

Answer 52

Perfectly inelastic supply—sellers pay.

Perfectly elastic supply—buyers pay.

Question 53

Fig 6.9(a)

Answer 53

Figure 6.9(a) shows the market for water from a mineral spring that flows at a constant rate that can’t be controlled. Supply is perfectly inelastic at 100,000 bottles a week, as shown by the supply curve S. The demand curve for the water from this spring is D. With no tax, the price is 50¢ a bottle and the quantity is 100,000 bottles.

Suppose this spring water is taxed at 5¢ a bottle. The supply curve does not change because the spring owners still produce 100,000 bottles a week, even though the price they receive falls. But buyers are willing to buy the 100,000 bottles only if the price is 50¢ a bottle, so the price remains at 50¢ a bottle. The tax reduces the price received by sellers to 45¢ a bottle, and sellers pay the entire tax.

Question 54

Fig 6.9(b)

Answer 54

Figure 6.9(b) shows the market for sand from which computer-chip makers extract silicon. Supply of this sand is perfectly elastic at a price of 10¢ a kilogram, as shown by the supply curve S. The demand curve for sand is D. With no tax, the price is 10¢ a kilogram and 5,000 kilograms a week are bought.

If this sand is taxed at 1¢ a kilogram, we must add the tax to the minimum supply-price. Sellers are now willing to offer any quantity at 11¢ a kilogram along the curve
S
+
tax
. A new equilibrium is determined where the new supply curve intersects the demand curve: at a price of 11¢ a kilogram and a quantity of 3,000 kilograms a week. The tax has increased the price buyers pay by the full amount of the tax—1¢ a kilogram—and has decreased the quantity sold. Buyers pay the entire tax.

Question 55

A tax makes marginal social benefit ________ marginal social cost, shrinks the producer surplus and consumer surplus, and creates a _______________.

Answer 55

A tax makes marginal social benefit exceed marginal social cost, shrinks the producer surplus and consumer surplus, and creates a deadweight loss.

Question 56

Fig 6.10

Answer 56

Figure 6.10 shows the inefficiency of a tax on MP3 players. The demand curve, D, shows marginal social benefit, and the supply curve, S, shows marginal social cost. Without a tax, the market produces the efficient quantity (5,000 players a week).

With a tax, the sellers’ minimum supply-price rises by the amount of the tax and the supply curve shifts to
S
+
tax
. This supply curve does not show marginal social cost. The tax component isn’t a social cost of production. It is a transfer of resources to the government. At the new equilibrium quantity (4,000 players a week), both consumer surplus and producer surplus shrink. Part of each surplus goes to the government in tax revenue—the purple area; part becomes a deadweight loss—the grey area.

Question 57

Only in the extreme cases of perfectly inelastic demand and perfectly inelastic supply does a tax not change the quantity bought and sold so that no ______________ arises.

Answer 57

Only in the extreme cases of perfectly inelastic demand and perfectly inelastic supply does a tax not change the quantity bought and sold so that no deadweight loss arises.

Question 58

The Benefits Principle

Answer 58

The benefits principle is the proposition that people should pay taxes equal to the benefits they receive from the services provided by government.

This arrangement is fair because it means that those who benefit most pay the most taxes. It makes tax payments and the consumption of government-provided services similar to private consumption expenditures.

The benefits principle can justify high fuel taxes to pay for highways, high taxes on alcoholic beverages and tobacco products to pay for public healthcare services, and high rates of income tax on high incomes to pay for the benefits from law and order and from living in a secure environment, from which the rich might benefit more than the poor.

Question 59

The Ability-to-Pay Principle

Answer 59

The ability-to-pay principle is the proposition that people should pay taxes according to how easily they can bear the burden of the tax.

A rich person can more easily bear the burden than a poor person can, so the ability-to-pay principle can reinforce the benefits principle to justify high rates of income tax on high incomes.

Question 60

Governments often use two other methods of intervention in the markets for farm products:

Answer 60

Production quotas

Subsidies

Question 61

Production quota

Answer 61

An upper limit to the quantity of a good that may be produced in a specified period.

Question 62

If the government introduced a production quota above the equilibrium quantity, ______________

Answer 62

If the government introduced a production quota above the equilibrium quantity, nothing would change because dairy farmers would already be producing less than the quota.

Question 63

A production quota set below the equilibrium quantity has big effects, which are: (5 things)

Answer 63

A decrease in supply

A rise in price

A decrease in marginal cost

Inefficient underproduction

An incentive to cheat and overproduce

Question 64

Fig 6.11

Answer 64

With no quota, farmers produce 16 million kilograms of milk (powder) a year and the price is $3 a kilogram. A production quota of 14 million kilograms a year restricts total production to that amount. The quantity produced decreases to 14 million kilograms a year, the price rises to $5 a kilogram, and the farmers’ marginal cost falls to $2 a kilogram. Because marginal social cost (on the supply curve) is less than marginal social benefit (on the demand curve), a deadweight loss arises from the underproduction.

In Fig. 6.11, with no quota, growers would produce 16 million kilograms of milk (powder) a year—the market equilibrium quantity. With a production quota set at 14 million kilograms a year, the grey-shaded area shows the illegal region. As in the case of price ceilings and price floors, market forces and political forces are in conflict in this illegal region.

The vertical red line labelled “Quota” becomes the supply curve of milk at prices above $2 a kilogram.

Question 65

When the government sets a production quota, it leaves market forces _______________.

Answer 65

When the government sets a production quota, it leaves market forces free to determine the price.

Because the quota decreases the supply of milk, it raises the price. In Fig. 6.11, with no quota, the price is $3 a kilogram. With a quota of 14 million kilograms, the price rises to $5 a kilogram.

Question 66

The production quota lowers the ____________ of producing milk.

Answer 66

The production quota lowers the marginal cost of producing milk.

Marginal cost decreases because farmers produce less and stop using the resources with the highest marginal cost.

Dairy farmers slide down their supply (and marginal cost) curves. In Fig. 6.11, marginal cost decreases to $2 a kilogram.

Question 67

The production quota results in _____________.

Answer 67

The production quota results in inefficient underproduction.

Marginal social benefit at the quantity produced is equal to the market price, which has increased. Marginal social cost at the quantity produced has decreased and is less than the market price. So marginal social benefit exceeds marginal social cost and a deadweight loss arises. (Fig 6.11)

Question 68

The production quota creates an incentive for farmers to _____________________________

Answer 68

The production quota creates an incentive for farmers to cheat and produce more than their individual production limit.

With the quota, the price exceeds marginal cost, so the farmer can get a larger profit by producing one more unit. Of course, if all farmers produce more than their assigned limit, the production quota becomes ineffective, and the price falls to the equilibrium (no quota) price. (Fig 6.11)

Question 69

To make the production quota effective, farmers must set up a ________________ to ensure that no one cheats and overproduces.

Answer 69

To make the production quota effective, farmers must set up a monitoring system to ensure that no one cheats and overproduces.

But it is costly to set up and operate a monitoring system and it is difficult to detect and punish producers who violate their quotas.

Question 70

Subsidy

Answer 70

A payment made by the government to a producer.

Question 71

The effects of a subsidy are similar to the effects of a tax but they go in the opposite direction. These effects are: (5 things)

Answer 71

An increase in supply

A fall in price and increase in quantity produced

An increase in marginal cost

Payments by government to farmers

Inefficient overproduction

Question 72

Fig 6.12

Answer 72

In Fig. 6.12, with no subsidy, the demand curve D and the supply curve S determine the price of grain at $40 a tonne and the quantity of grain at 40 million tonnes a year.

Question 73

A subsidy is like a _________.

Answer 73

A subsidy is like a negative tax.

A tax is equivalent to an increase in cost, so a subsidy is equivalent to a decrease in cost.

Question 74

The subsidy brings an ___________.

Answer 74

The subsidy brings an increase in supply.

Question 75

To determine the position of the new supply curve, we subtract _______________________.

Answer 75

To determine the position of the new supply curve, we subtract the subsidy from the farmers’ minimum supply-price.

In Fig. 6.12, with no subsidy, farmers are willing to offer 40 million tonnes a year at a price of $40 a tonne. With a subsidy of $20 a tonne, they will offer 40 million tonnes a year if the price is as low as $20 a tonne. The supply curve shifts to the red curve labelled S−subsidy.

Question 76

The subsidy ______ the price of grain and ________ the quantity produced. (Fig 6.12)

Answer 76

The subsidy lowers the price of grain and increases the quantity produced.

In Fig. 6.12, equilibrium occurs where the new supply curve intersects the demand curve at a price of $30 a tonne and a quantity of 60 million tonnes a year.

Question 77

The subsidy ________ the price paid by consumers but ________ the marginal cost of growing grain.

Answer 77

The subsidy lowers the price paid by consumers but increases the marginal cost of growing grain.

Marginal cost increases because farmers grow more grain, which means that they must begin to use some resources that are less ideal for growing grain. Farmers slide up their supply (and marginal cost) curves. In Fig. 6.12, marginal cost increases to $50 a tonne.

Question 78

The government pays a _______ to farmers on each tonne of grain produced

Answer 78

The government pays a subsidy to farmers on each tonne of grain produced

In this example, farmers increase production to 60 million tonnes a year and receive a subsidy of $20 a tonne. So farmers receive payments from the government that total $1,200 million a year. (Fig 6.12)

Question 79

The subsidy results in _____________.

Answer 79

The subsidy results in inefficient overproduction.

At the quantity produced with the subsidy, marginal social benefit is equal to the market price, which has fallen. Marginal social cost has increased and it exceeds the market price. Because marginal social cost exceeds marginal social benefit, the increased production brings inefficiency.

Question 80

A subsidy _______ the domestic market price, subsidized farmers will offer some of their output for sale on the _________.

Answer 80

A subsidy lowers the domestic market price, subsidized farmers will offer some of their output for sale on the world market.

The increase in supply on the world market lowers the price in the rest of the world. Faced with lower prices, farmers in other countries decrease production and receive smaller revenues.

Question 81

Fig 6.13

Answer 81

Figure 6.13 shows the market for a drug. The demand curve, D, shows that, other things remaining the same, the lower the price of the drug, the larger is the quantity of the drug demanded. The supply curve, S, shows that, other things remaining the same, the lower the price of the drug, the smaller is the quantity supplied. If the drug were not illegal, the quantity bought and sold would be QC and the price would be PC

Question 82

When a good is illegal, the cost of trading in the good _________.

Answer 82

When a good is illegal, the cost of trading in the good increases.

By how much the cost increases and who bears the cost depend on the penalties for violating the law and the degree to which the law is enforced. The larger the penalties and the better the policing, the higher are the costs. Penalties might be imposed on sellers, buyers, or both.

Question 83

To determine the new supply curve (Penalties on Sellers), we add the _______________ to _______________.

Answer 83

To determine the new supply curve, we add the cost of breaking the law to the minimum price that drug dealers are willing to accept.

In Fig. 6.13, the cost of breaking the law by selling drugs (CBL) is added to the minimum price that dealers will accept and the supply curve shifts leftward to
S+CBL. If penalties were imposed only on sellers, the market equilibrium would move from point E to point F.

Question 84

the cost of breaking the law must be subtracted from the ______________ to determine the maximum price buyers are willing to pay for the drugs.

Answer 84

the cost of breaking the law must be subtracted from the value of the good to determine the maximum price buyers are willing to pay for the drugs.

Demand decreases, and the demand curve shifts leftward. In Fig. 6.13, the demand curve shifts to D−CBL. If penalties were imposed only on buyers, the market equilibrium would move from point E to point G.

Question 85

If penalties are imposed on both sellers and buyers, both ____________ and ____________ decrease and both the ____________ and the ____________ shift.

Answer 85

If penalties are imposed on both sellers and buyers, both supply and demand decrease and both the supply curve and the demand curve shift.

In Fig. 6.13, the costs of breaking the law are the same for both buyers and sellers, so both curves shift leftward by the same amount. The market equilibrium moves to point H. The market price remains at the competitive market price PC, but the quantity bought decreases to QP. Buyers pay PC plus the cost of breaking the law, which equals PB. Sellers receive PC minus the cost of breaking the law, which equals PS.

Question 86

The larger the penalties and the greater the degree of law enforcement, the larger is the __________ in demand and/or supply.

Answer 86

The larger the penalties and the greater the degree of law enforcement, the larger is the decrease in demand and/or supply.

Question 87

If the penalties are heavier on sellers, the supply curve shifts farther than the demand curve and the market price __________ PC. (Fig 6.13)

Answer 87

If the penalties are heavier on sellers, the supply curve shifts farther than the demand curve and the market price rises above PC.

Question 88

If the penalties are heavier on buyers, the demand curve shifts farther than the supply curve and the market price __________ PC. (Fig 6.13)

Answer 88

If the penalties are heavier on buyers, the demand curve shifts farther than the supply curve and the market price falls below PC.

Question 89

With high enough penalties and effective law enforcement, it is possible to decrease demand and/or supply to the point at which the quantity bought is zero. But in reality, such an outcome is unusual. It does not happen in Canada in the case of illegal drugs. The key reason is ________________________.

Answer 89

With high enough penalties and effective law enforcement, it is possible to decrease demand and/or supply to the point at which the quantity bought is zero. But in reality, such an outcome is unusual. It does not happen in Canada in the case of illegal drugs. The key reason is the high cost of law enforcement and insufficient resources for the police to achieve effective enforcement.

Because of this situation, some people suggest that drugs (and other illegal goods) should be legalized and sold openly but also taxed at a high rate in the same way that legal drugs such as alcohol are taxed

Question 90

Which is more effective: prohibition or taxes?

In favour of taxes and against prohibition is the fact that the tax revenue can be used to make ________________.

Answer 90

In favour of taxes and against prohibition is the fact that the tax revenue can be used to make law enforcement more effective.

It can also be used to run a more effective education campaign against illegal drug use.

Question 91

Which is more effective: prohibition or taxes?

In favour of prohibition and against taxes is the fact that prohibition sends a signal that _______________________.

Answer 91

In favour of prohibition and against taxes is the fact that prohibition sends a signal that might influence preferences, decreasing the demand for illegal drugs.

Also, some people intensely dislike the idea of the government profiting from trade in harmful substances.