ECO1000 Economics

1. ECO1000Economics Semester One, 2004 Lecture Five

2. Cancellation of Workshops • Due to small numbers, the workshops on Monday 11-1 and Monday 12-2 have been cancelled effective immediately. • Students are requested to choose: • Tuesday 10-12 (T124) if possible. • If this is not appropriate, please see the course leader.

3. Class test 1 Reminder (internals incl. Wide Bay students) • April 7 (Next Week) • Test open from 5 pm-8pm • 25 questions • Based on lectures & all workshop activities • Make sure you have • Graph paper (to help you work out the correct answers) • Rulers and pens • Calculator • Text Book etc

4. How to Access the Test (internals) • The instructions are as follows… • (students at the lecture were shown the online procedures) • Please note: students who have not payed their guild fees or non-deferred HECS may not be able to access the test. An alternative can be arranged if this occurs.

5. In Case of Technical Difficulties… • Note the problem • Contact the CMA administrator • If a solution is not forthcoming, contact your lecturer the next morning • There will be an electronic record of all those who tried to, or actually accessed the test • You must be on this list to qualify for further consideration

6. Outline or Plan of Today’s Lecture • Material Covered: Module Two, Part Three • Reading: Text Chapter Six, Hakes and Parry Chapter Six • Topics: Markets and Government Policy

7. Purpose or Objectives of This Lecture • You will learn about: • The effects of government policies (ceilings and floors) on prices • The effect of taxes on the price of a good and quantity sold • The burden of taxes on consumers or producers

8. Relevant Economic Principles • 6. Markets are usually a good way to organise economic activity • 7. Governments Can Sometimes Improve Market Outcomes

9. A Starting Point Free Markets

10. Defining ‘free’ (unregulated) markets • There is freedom of production & consumption • Most economic activity is done by the private sector • There should be competition amongst buyers and sellers • But private contracts have legal backing

11. The Benefits of Free Markets Are:(according to classical theory) • Individual freedom • Efficiency in production • because competition leads to innovation • Allocative efficiency • resources used in most efficient way • the best way to shift goods & services around • Higher average standards of living

12. ‘Creative Destruction’ • Technological innovation increases efficiency • Productivity increases • Labour is replaced by capital • (some) labour shifts to ‘new’ industries • ‘New’ industries became a greater proportion of the national economy

13. Reasons Why Governments Might Limit Market Freedom • To achieve equity or greater equality • To protect the economically weak • To protect or nurture a socially desirable industry • To gain votes • To prevent or limit externalities • Ensure social or economic stability

14. Government Intervention Aimed at Producers

15. Assistance for Producers • Tariffs on imported goods • Mandated monopolies • Preferred purchasing agreements • Subsidies

16. Subsidising Producers • Grant (lump sum payment) • eg for start-up capital • Tariff (tax on imported/competing product) • Tax deductions on expenditure • Subsidised infrastructure & research • Payment per unit produced

17. The Effect of a Subsidy Price S0 S1 P0 P1 D0 Q0 Quantity Q1

18. Points to Note • A subsidy/unit effectively lowers the cost of production • The supply curve shifts to the right • Both consumers and producers benefit • Classical economics’ criticism: • Taxpayers pay • Insulates producers from market signals

19. Price Floor (minimum price) P1 is the minimum price allowed. The price cannot fall below that. Price S0 NB a floor price set below equilibrium will have no effect P1 P0 D0 Q0 Quantity Q1

20. Points to Note • The minimum price can be set legally or by having a marketing body that stockpiles • At the higher price, consumers only want Q1, so the quantity sold tends to decrease • this would be less so if it was an inelastic good • Criticism • consumers buy less than they otherwise would • it sends the wrong market signal to producers

21. Surplus Production Producers get the ‘signal’ to produce Q2, while consumers only want Q1 Price Surplus production S0 P1 P0 Surplus = Q2 - Q1 D0 Q0 Q2 Quantity Q1

22. Government Intervention Aimed at Consumers

23. Assistance for Consumers • Product standard and safety laws • ‘Truth in advertising’ laws • Civil courts • Australian Competition & Consumer Council looks for • anti-competitive behaviour • standards and trade practices

24. Price Ceiling (maximum price) P1 is the maximum price allowed. The price cannot rise above that. Price S0 NB a ceiling price set above equilibrium will have no effect P0 P1 D0 Q0 Quantity Q1

25. A Shortage in Production Consumers want Q2 but producers get the ‘signal’ to produce Q1 so there will be an excess of demand (shortage). Price S0 Shortage P0 Shortage = Q2 – Q1 P1 D0 Quantity Q0 Q2 Q1

26. Criticisms of Intervention • The problem of ‘rent-seeking’ by producers • Lack of competition • Higher prices for consumers • Collusion by small number of producers • Inefficient allocation of resources • Reduces pressure for innovation • Protection locks out developing countries

27. Market Deregulation • Governments respond to the classical criticisms

28. Microeconomic Reform • Reduce tariffs • Remove ‘non-tariff’ barriers • Reduce direct & indirect subsidies • Privatisation of govt enterprises • Deregulate financial markets • Competition ‘watchdogs’ & rules

29. Deregulation (removing a price floor) If P0 is removed then the the ‘new’ price is P1 and the ‘new’ quantity is Q1 Price S0 P0 P1 D0 Quantity Q1 Q0

30. A Case Study of Labour Markets

31. Characteristics of labour markets • Households supply labour • The quantity is in hrs/wk, month or year • Firms demand labour • The price is the wage rate/hr/mth/yr • In the absence of regulation, the wage rate is set by market signals • the conjunction of supply and demand

32. Labour Market Intervention • Maintain employment in certain regions • Stop exploitation of ‘powerless’ workers • Standard working conditions easier to enforce • Use minimum wages to boost household income • A form of income redistribution • Profits to wages

33. Some Possible Government Policies • Subsidise/assist industry • to stimulate employment demand • Increase value through education etc • supply side policies • Wage/training subsidies • Minimum wage laws

34. Minimum Wage Policy Price SL0 W1 W0 DL0 Quantity QL0 QL1

35. Unemployment (according to the classical view) Workers want to supply QL2 hours while firms only want to emplyQL1 hours. Price Unemployment? SL0 W1 W0 No. of unemployed = QL2 – QL1 DL0 QL0 QL2 Quantity QL1

36. The Argument for Labour Market Deregulation… • Business wants to pay less in wages • Government wants more people to be employed • BUT…LOWER WAGES DO NOT ALWAYS LEAD TO LOWER UNEMPLOYMENT (this is discussed more in a later lecture)

37. Taxation and Markets

38. Needed for government services Income redistribution Possible instrument of economic management Disincentive for working hard Disincentive for investment Tax revenue ‘wasted’ by governments TaxationFOR AGAINST

39. A Tax Increases price, reduces quantity sold Price S1 S0 Ptax Tax paid ($/unit) = Ptax- P2 P0 P2 D0 Quantity Q0 Qt

40. A Tax Price S1 S0 Pt Total tax paid = (Pt- P2) x Qt P0 P2 D0 Q0 Quantity Qt

41. The Distribution of the Tax Burden • When a tax is imposed: • consumers pay more than they did, because of the higher price • producers receive less than they did because the reduction in quantity demanded effectively shifts them down the (S0) supply curve • Therefore, both consumers and producers ‘contribute’ to tax revenue

42. A Tax Price Stax S0 Consumer share of tax Pt P0 Producer share of tax P2 D0 Q0 Quantity Qt

43. Points to note • Consumers pay Pt −P0 more for the good • They pay total tax of (Pt− P0) x Qt • Producers receive P0− P2 less for the good • They pay total tax of (P0− P2) x Qt • Producer revenue is now P2 x Qt

44. A Tax Question • If the equilibrium price was $20/unit. • A $6/unit tax is imposed and the government receives $12,000/wk in tax revenue. • Producers revenue is now $36,000. What is the new price (with tax) of the unit?

45. What We Know Tax/unit = $6 = Pt - P2 Price St S0 Govt. revenue = $12,000 Pt 20 Producer revenue = $36,000 P2 D0 Q0 Quantity Qt

46. Govt revenue = Qt x $6 = $12,000/wk • therefore Qt = 2000 units/wk • Producer revenue = $36,000 = Qt x P2 • therefore 36,000 = 2000 x P2 • therefore P2 = $18 • Pt = P2 + tax rate • Pt = 18 + 6 = $24/unit = new price

47. Tax and Elasticity Price Stax S0 Pt Consumer contribution P0 Producer contribution P2 D0 Q0 Quantity Qt

48. Tax and Elasticity • The more inelastic the good, the more likely it is that consumers will ‘pay’ the greatest share of the tax burden. • The quantity does not fall as much so the producers are somewhat insulated from the effect.

49. Tax on an Elastic Good St S0 Consumer’s share of tax D Producer’s share of tax When demand is more elastic than supply, producers pay more of the tax

50. Conclusions • Whilst markets are usually a good way to organise activity, governments do intervene. • Government policies may be aimed at assisting producers, consumers or both. • Government policies have an impact on prices and quantities.