Taxes and marginal cost pricing

1. Taxes and marginal cost pricing Today: Results of taxation; Marginal cost pricing and efficiency

2. 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 marginal cost pricing

3. 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. 10) Limitation of imports (more on this later in trade lecture) Taxes

4. An example: A $1 tax on flashlight suppliers • Before tax: Price is $8.80, and 8 flashlights sold

5. An example: A $1 tax on flashlight suppliers • With tax: Suppliers must add $1 in additional costs for each flashlight sold

6. 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

7. 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

8. What happens with a $1 tax? • Summary • Lower quantity sold • Consumers pay more money per unit sold • Sellers receive less money per unit sold

9. 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

10. Surplus and deadweight loss • Consumer surplus (top Δ) • Producer surplus (bottom Δ) • Tax revenue generated (rectangle) • Deadweight loss (right Δ)

11. More on deadweight loss • An example related to elasticity • The smaller the price elasticity of supply, the smaller the deadweight loss • More on deadweight loss in monopoly and externality chapters

12. Marginal cost pricing of public services • Governments often provide (or contract to a private firm) some “essential” services to residents

13. 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

14. 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

15. 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 Example

16. The invisible hand • Next time, we will begin to investigate a concept called “the invisible hand” • Important to know types of profit • Accounting profit • Normal profit • Economic profit • On next two slides, I introduce some questions for you to think about

17. Questions to ponder over the weekend • Why are TV repair shops harder to find? • Why has Las Vegas added many expensive hotels on its famous strip?

18. Emma the plumber She could either run a home business or work next door at AAA Plumbing at $30 per hour Either way: 40 hours / week 50 weeks / year If she works at home, she assumes that her annual revenues and costs will be as follows Total revenue: $200,000 Explicit costs: $160,000 Emma the plumber: What should she do? (More on Monday)