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ECO101H1 Week 3
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Lecture notes of 5 pages for the course ECO101H1 at U of T (Week 3 notes)
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4.3 - Elasticity matter for excise taxes- Excise taxes is a tax on the sale of a specific product (cigarettes, alcohol, gasoline)
- The sellers collect the tax on behalf of the government and then remit the tax collections
- Firms write a cheque to the gv=government saying they are the ones paying the whole tax but
consumers argue that since the tax has increased prices, that they are paying more of the tax.
- Tax incidence is an application of demand-and supply analysis that will show that tax incidence
has nothing to do with wether the government collects the tax directly from consumer of from
firms (the burden of an exercise tax is distributed between consumers and sellers in a
manner that depends on the relative elasticities of supply and demand)
- EXAMPLE: Sales tax on gasoline: the leftward shift of the supply curve, caused by the
imposition of the excise tax, will cause a movement along the deman curve, reducing the
equilibrium quantity
- At this new equilibrium E1, the consumer price rises to Pc which was greater than the previous
pric, the seller price falls and the equilibrium quantity falls. The difference in the new price of
gasoline and the price that producers pay is the amount of tax one has to pay
- After an imposition of an excise tax, the difference between the consumer and seller prices
equal to the tax. In the new equilibrium, the quantity exchanged is less that what occurred
without the tax
- When the demand is inelastic (not many substitutes) most of the burden of the tax falls on the
consumers shoulders, because the change in quillibiru quantity is low but the new price is much
higher
- When the supply is inelastic (consumers can easily substitute) most of the burden of the tax falls
on the producers shoulder
Chapter 5
5.1 Government-controlled prices
- Government price controls are policies that attempt to hold the price at some disequllibirum
value. Some controls hold the market price below its equilibrium while others hold price above,
creating a surplus at the controlled price
- What determines quantity actually exchanged when price controls are in effect?
- If a particular price, quantity demanded is less than quantity supplied, demand will determine the
amount actually exchanged while rest of the quantity supplied will remain in the hands of
unsuccessful sellers. And Vise versa
- At any disequilibrium price, quantity exchanged is determined by the lesser of quantity
demanded or quantity supplied
, Price floors
- The minimum price that can be charged for a particular good or service
- A price floor will have to be placed above market equilibrium in order to be binding
- Rules that establish price floor are (making products illegal to sell, minimum wage, garantuee of a
certain price by buying any excess supply)
- A binding price floors lead to excess supply and the consequences of excess supply differ from
product to product
- If the product is labour services, subject to a minimum wage, excess supply translates into rising
unemployment rates
- If the product is wheat on the other hand, and more is produced than can be sold to costumer, the
surplus wheat will accumulate in grain elevators of government warehouses
- Good things and bad things about price floors and why government does them?
- Price floors give producers an advantage of selling their goods above the free-market
price. However, this also creates 2 groups of sellers. Those who were lucky and were able
to sell their product at a higher price, and those who were not so lucky since demand did
decrease, and ended up with an excess of supply
- Note: depending on the elasticity of demand, there might not be an excess amount of
consumers lost as price rises
- The debate about minimum wage
- We can argue that raising prices will increase the supply of the labour, but at the same time,
higher cost of labour decreases the demand of firms for more labour meaning, some workers are
better off since they got jobs at higher wages, and others have no job because demand for labour
has fallen
Price ceilings
- Price ceiling is the maximum price at which a certain good and service may be legally exchanged
(oil, natural gas, housing rental)
- A price ceiling must be set below the market price in order to have any affect
- Binding price ceilings lead to excess demand, with the quantity exchanged being less than in the
free-market equilibrium
- Sellers preference is when scalpers also known as people who buy blocks of first come first
serve tickets and then sell it at market-clearing prices. Sometimes the scalpers might choose
themselves who they want to sell to which is a small selection of people also known as sellers
preference
Black markets
- Binding price ceilings give potential for black markets to be created because a profit can be made
buying at the controlled price and selling the illegal black-market price
- 3 common goals when government set a price ceiling are,
- To restrict production (to release resources for other uses)
- To keep specific prices down
- To satisfy notions of equity in the consumption of product that is temporarily in short
supply
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