taxes, mc pricing, and a wrap-up of supply/demand today: finishing the basic ideas of supply and...
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Taxes, MC pricing, and a wrap-up of supply/demand
Today: Finishing the basic ideas of supply and demand
theory
From subsidies to taxes to MC pricing Last time, we saw that a subsidy did not
work to help high rent in Isla Vista Today, we talk more generally about a
negative subsidy, which is called a tax After taxes, we will talk about MC
pricing Once these topics are done, we will
spend the remaining time reviewing Econ 1 thus far
Taxes Governor Arnold
Schwarzenegger below
Three major reasons to charge taxes Revenue generation The prevention of
harming the environment or other people (see also Externalities, Ch. 12)
Limitation of imports (see also Trade, Ch. 9)
An example: A $1 tax on flashlight suppliers
Before tax: Price is $8.80, and 8 flashlights sold
An example: A $1 tax on flashlight suppliers
With tax: Suppliers must add $1 in additional costs for each flashlight sold
An example: A $1 tax on flashlight suppliers
With tax: New equilibrium
price paid is $9.20 by consumers
New equilibrium revenue kept by suppliers, $8.20
An example: A $1 tax on flashlight suppliers Who “pays” for
the tax? Consumers pay
$0.40 more than before
Suppliers receive $0.60 less than before
What happens with a $1 tax? Summary
Lower quantity sold
Consumers pay more money per unit sold
Sellers receive less money per unit sold
Deadweight loss
Deadweight loss is economic surplus that we lose by the imposition of a tax
To determine deadweight loss, we need to find surplus and tax revenue generated by tax
Any potential surplus not realized is deadweight loss
Surplus and deadweight loss Consumer
surplus (top Δ) Producer surplus
(bottom Δ) Tax revenue
generated (rectangle)
Deadweight loss (right Δ)
Elasticity matters for deadweight loss
An example The smaller the price elasticity of
supply, the smaller the deadweight loss
See Figures 7.16 and 7.17 for visual examples
Marginal cost pricing of public services Governments often provide (or contract
to a private firm) some “essential” services to residents
Back to MB = MC idea
Remember 1st lecture Surplus is typically maximized when
MB = MC Even though services are publicly
provided, MB = MC still applies
Example
Electricity 8 Mwh can be provided by coal @
3¢/Kwh 20 Mwh can be provided by natural gas
@ 5¢/Kwh 10 Mwh can be provided by wind
power @ 9¢/Kwh 6 Mwh can be provided by solar power
@ 15¢/Kwh
Example 8 Mwh (coal) @
3¢/Kwh 20 Mwh (natural gas)
@ 5¢/Kwh 10 Mwh (wind
power) @ 9¢/Kwh 6 Mwh (solar power)
@ 15¢/Kwh
Suppose that at a price of 9¢/Kwh, 30 Mwh were demanded
All coal capacity and natural gas capacity can be used, and 2 Mwh provided by wind
MC pricing tells us to charge 9 ¢/Kwh in order to maximize surplus
Wrap-up and review of supply, demand, and equilibrium We have talked
about many topics related to supply, demand, and equilibrium thus far
Utility Surplus Cost curves Elasticity Price controls Taxes and
subsidies Voluntary
incentives
Wrap-up and review of supply, demand, and equilibrium
In general, we have analyzed efficiency MB = MC principle
Some policies prevent MB = MC principle, lowering efficiency Rent control Taxes and subsidies First-come, first-served
Wrap-up and review of supply, demand, and equilibrium
Many future topics build off of what we have learned thus far
It is important to make sure that you understand the foundation of microeconomics, which we have covered the last three weeks
Marginal analysis
Remember that averages are sometimes important in economics
Marginals are almost always important
Some later topics include why markets sometimes fail Marginal analysis will continue to be
important
Supply, demand, and equilibrium
Remaining time today Your chance to ask questions before
we move on to more advanced topics Review of key equations, tables, and
figures
Energy drinks
# of drinks Total benefit ($) MB ($) Avg. benefit
0 0 N/A5
1 5 53
2 8 4
2.53 10.5 3.5
1.54 12 3
-15 11 2.2
Cost is $2 per drink We should buy the third
energy drink since MB > MC (2.5 > 2)
We should not buy the fourth energy drink since MB < MC (1.5 < 2)
Note that we are NOT maximizing avg. benefit
Supply and Demand
Shift in demand/Movement along the supply curve
The demand curve shifted to the right
There is a movement along the supply curve, since supply does not change
MU of bananas: How many would you eat if they were free?
Banana quantity (bananas/hour)
Total utility (utils/hour)
Marginal utility (utils/banana)
0 0
70
1 70
50
2 120
30
3 150
10
4 160
-10
5 150
From individual demand…
…to market demand
CS from demand curves P = $3 Height of triangle
is ($6 – $3), or $3. Length of triangle
is (6 – 0), or 6 Area of triangle is
one-half times length times height
CS = $9
The area of this triangle is a good approximation of CS
Supply and profits
At P1 positive profits, since TR > TC (P Q > ATC Q)
At P2 negative profits
At P3 firm shuts down (TR is less than VC for all Q)
Marginal analysis: Hire 4 workers/day if phones are $18
# of empl./day
Phones per day
Fixed cost ($/day)
Var. cost ($/day)
Total cost ($/day)
MC ($/phone)
0 0 1000 0 1000
5.00
1 20 1000 100 1100
4.00
2 45 1000 200 1200
10.00
3 55 1000 300 1300
12.50
4 63 1000 400 1400
20.00
5 67 1000 500 1500
(Remember: Check shutdown condition)
Example of producer surplus When P = 25 per
unit, shaded area is producer surplus
Area is a triangle, one-half times length times height: 0.5 10 25 = 125
Price elasticity of demand Calculated by the
percentage change in quantity divided by the percentage change in price
P
QElasticity
%
%
Alternate version for straight-line demand curves
Slope on straight line is ΔP/ΔQ Along a straight line, elasticity is also equal
to P/Q times inverse of the slope (see above)
slopeQ
P
P
Q
Q
P
PP
QQ 1
/
/
Bumper crop of strawberries: Not always good ε = 0.29 inelastic Expenditure goes
DOWN moving from S1 to S2
The bumper crop of strawberries actually hurts farmers collectively
Long-run consequences of rent control: Excess demand Notice that
supplied apartments for rent are cut in half in the long run with rent control
Only 1/3 of the people that want apartments will get them
($100s)
100s units
12
24excess demand
Price ceiling at G: Red triangle is deadweight loss Total surplus is
trapezoid ADFE (at most)
ΔCEF is potential surplus that is never gained
A $1 tax on flashlight suppliers Who “pays” for
the tax? Consumers pay
$0.40 more than before
Suppliers receive $0.60 less than before
Surplus and deadweight loss Consumer
surplus (top Δ) Producer surplus
(bottom Δ) Tax revenue
generated (rectangle)
Deadweight loss (right Δ)