SUMMARY CHAPTER 8 BOOK ECONOMICS N. Gregory Mankiw, Mark P. Taylor, Schemi e mappe concettuali di Economia Internazionale

Scarica SUMMARY CHAPTER 8 BOOK ECONOMICS N. Gregory Mankiw, Mark P. Taylor e più Schemi e mappe concettuali in PDF di Economia Internazionale solo su Docsity! Cap 8. GOVERNMENT POLICIES Markets can generate outcomes which are efficient. Whilst market outcomes can be efficient, they are not always fair. CONTROLS ON PRICES We will look at two policies to control prices – price ceilings and price floors. These policies may be introduced by a government or a regulatory body but in some cases might also be set by a business. A price ceiling or a price cap is a legal maximum on the price at which a good can be sold. A price floor is the exact opposite – a minimum price that producers can charge for a good. price ceiling a legal maximum on the price at which a good can be sold price floor a legal minimum on the price at which a good can be sold To see how price controls affect market outcomes, we will look at an example which has interested economists for many years – rent control. If rental space for residential occupation (we will define this in terms of square metres) is sold in a competitive market free of government regulation, it is assumed that the price of housing adjusts to balance supply and demand: at the equilibrium price, the quantity of housing that buyers want to buy exactly equals the quantity that sellers want to sell. House seekers and landlords lobby the government to pass laws that alter the market out- come by directly controlling the price of rental accommodation. If those seeking rental accommodation are successful in their lobbying, the government imposes a legal maximum on the price at which rental accommodation can be sold. Our model of the market allows us to make some predictions about what the effects of such a policy might be. How Price Ceilings affect market outcomes When a price ceiling is imposed, two outcomes are possible. In panel (a) of Figure 8.1, the government imposes a price ceiling of €40 per m. In this case, because the price that balances supply and demand (€30 per m2) is below the ceiling, the price ceiling is not binding. The price in the market will level out at the equilibrium price of €30 per m, and the price ceiling has no long-term effect on the price, or the quantity sold. Figure 8.1 A market with a Price Ceiling In panel (a), the government imposes a price ceiling of €40 per m. Because the price ceiling is above the equilibrium price of €30 per m, the price ceiling has no effect, and the market can reach the equilibrium of supply and demand. In this equilibrium, quantity supplied, and quantity demanded both equal 5 million square feet. In panel (b), the government imposes a price ceiling of €20 per m. Because the price ceiling is below the equilibrium price of €30 per m, the market price equals €20 per m. At this price, 6 million square feet is demanded and only 4 million square feet is supplied, so there is a shortage of 2 million square feet. In panel (b) of Figure 8.1, the government imposes a price ceiling of €20 per m. Because the equilibrium price of €30 per m2 is above the price ceiling, the ceiling is a binding constraint on the market. Given this binding limit on price, incentives change. Some landlords will not find it profitable to rent out property at this price and remove the property from the market. For buyers, the lower price of rental accommodation means the sacrifice they have to make is less in terms of alternatives foregone and so the demand for rental accommodation increases at the binding price. When a shortage of rental accommodation develops because of this price ceiling, some mechanism for rationing accommodation will develop. The mechanism could simply be long queues, or it is possible that an underground economy (sometimes referred to as a black market) can develop where those that are prepared to pay above the price ceiling rent, find a way of securing accommodation. This outcome is possible but also illegal, although there are often ways to ‘dress up’ a black-market solution to make it harder for the authorities to catch and prosecute those taking part in the practice. Sellers could decide to ration accommodation according to their own personal biases, selling it only to friends, relatives, or members of their own racial or ethnic group. The price ceiling will also affect sellers, and some may not feel it is worth their while continuing in the market and leave, thus depressing market supply. How Price floors affect market outcomes To examine the effects of another kind of government price control, let’s look at the market for alcohol. Governments in both England and Scotland have discussed the possibility of introducing minimum prices for alcohol to try and curb the damaging effects of excess alcohol consumption on both their citizens' health and on social behavior. If a government imposes a price floor on the market for alcohol, we can use our model to predict two possible outcomes. If the government imposes a price floor of €0.25 per unit when the equilibrium price is €0.35, we obtain the outcome in panel (a) of Figure 8.2. In this case, because the equilibrium price is above the floor, the price floor is not binding. Market forces move the economy to the equilibrium, and the price floor has no effect. Figure 8.2 A market with a Price floor In panel (a), the government imposes a price floor of €0.25 per unit. Because this is below the equilibrium price of €0.35 per unit, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 5 million units. In panel (b), the government imposes a price floor of €0.45 per unit, which is above the equilibrium price of €0.35 per unit. Therefore, the market price equals €0.45 per unit. Because 6 million units are supplied at this price and only 3 million are demanded, there is a surplus of 3 million units. Panel (b) of Figure 8.2 shows what happens when the government imposes a price floor of €0.45 per unit. In this case, because the equilibrium price of €0.35 per unit is below the floor, the price floor is a binding constraint on the market. At this floor, the quantity of alcohol supplied, 6 million units, exceeds the quantity demanded (3 million units), thus, a binding price floor causes a surplus. Summary Price controls are used when governments or other agencies believe that the market is not allocating resources equitably. There are other options available to governments for achieving what might be seen as being equitable outcomes and we shall look at these in more detail in the next section when we look at taxes and subsidies. TAXES Most governments, whether national or local, impose taxes to raise revenue and influence behavior in some way. There are many different taxes in most countries, but we can generally divide them into two categories: taxes on income and taxes on spending. Taxes on income are called direct taxes because the individual is ultimately responsible for paying the correct amount of tax. direct taxes a tax levied on income and wealth Taxes on expenditure are referred to as indirect taxes. An indirect tax might be levied on a business that is responsible to the tax authorities to pay the tax, but the business might pass on the tax to the consumer in the form of a higher price. Hence, the individual shares the burden of the tax and so contributes indirectly to the tax. indirect tax a tax levied on the sale of goods and services We can further identify two types of tax on expenditure – a specific tax and an ad valorem tax. A specific tax is a set amount per unit of expenditure, for example, €0.75 per litre of petrol or €2.50 on a bottle of whisky. An ad valorem tax is expressed as a percentage, for example a 10 per cent tax or a 20 per cent tax. There is a difference in the way in which these types of taxes affect market outcomes. In analyzing these outcomes, we will look at who taxes initially affect and how the burden of the tax is shared – in other words, who actually pays the tax? Economists use the term tax incidence to refer to the distribution of a tax burden. specific tax a fixed rate tax levied on goods and services expressed as a sum per unit ad valorem tax a tax levied as a percentage of the price of a good tax incidence the manner in which the burden of a tax is shared among participants in a market How Taxes on sellers affect market outcomes We are first going to analyze the market outcomes of a government imposing a specific tax and an ad valorem tax on sellers. A Specific Tax Suppose the government imposes a tax on sellers of petrol of €0.50 for each litre of fuel they sell. We analyze the effects of this tax by applying our three steps approach.