Unit 2.4: Market Failure and the Role of Government U nit Overview

1. Unit 2.4: Market Failure and the Role of Government Unit Overview Reasons for market failure ·Positive and negative externalities, with appropriate diagrams ·Short-term and long-term environmental concerns, with reference to sustainable development (IB only) ·Lack of public goods ·Underprovision of merit goods ·Overprovision of demerit goods ·Abuse of monopoly power Possible government responses ·Legislation ·Direct provision of merit and public goods ·Taxation ·Subsidies ·Tradable permits ·Extension of property rights ·Advertising to encourage or discourage consumption ·International cooperation among governments Blog posts: "Market Failure" Blog posts: "Environment" Blog posts: "Externalities" Blog posts: "Public goods"

2. Market Failure Introduction Discussion Questions: 1) What is market economics and why do we study it? 2) What types of markets are efficient? What types of market are inefficient? 3) Identify the various roles government has played in our study of economics up to this point. 4) Identify two examples of instances in which the economic behavior of one individual has a negative effect on another individual. 6) What are some examples of goods or services that you've consumed that were not provided by the free market? 7) What is a "market failure"?

3. Market Failure Introduction Market Failure: The market has failed when it results in either an over or an under-allocation of resources towards a particular product. Examples of markets failing: ·The market has failed because too many cigarettes are being produced and consumed in the world today. ·The market has failed because without state funded public schools, not enough educational institutions would be available for the nation's youth. ·The market has failed because without the government providing an Army, Navy and Air Force, not enough national defense would be provided for the country's citizens. ·The market has failed because too many people have driven SUVs for too long, resulting in greenhouse gasses to concentrate in the earth's atmosphere, contributing to global warming. Audio examples of market failure Nauru.mp3 E-waste.mp3 Trash Island.mp3

4. Market Failure Types of market failure Sometimes markets fail by... Not providing ANY of a particular good or service that benefits society, i.e. national defense, street lights, paved roads, park benches, city parks, etc. These things are called... Public goods: goods and services that will not be provided by the free market. Government must provide public goods. Sometimes markets fail by... Not providing ENOUGH of a particular good or service that benefits society, i.e. education, health care, sporting events, scientific research, museums, rail transportation, airports, art, etc. These things are called... Merit goods: goods and services that are under-provided by the free market. Government may choose to help subsidize or provide merit goods.

5. Market Failure Types of market failure Sometimes markets fail by... Providing TOO MUCH of a particular good or service that harms others in society, i.e. tobacco, heroine, child pornogrophy, coal-generated electricity, greenhouse gas-intensive industry, alcohol, etc. These things are called... Demerit goods: goods and services that are over-provided by the free market. Government is needed to regulate the production and consumption of these goods, either through taxes, direct controls, bans, etc... Global warming a "giant market failures"?.mp3 Market Failure and Externalities... Positive Externalities: When the production or consumption of a product creates external benefits for a third party not involved in the market transaction, or for society as a whole. Merit goods create positive externalities of consumption. Negative Externalitites: When the production or consumption of a product places external costs on a third party not involved in the market transaction, or society as a whole. Demerit goods create negative externalities of consumption or production. Intro to externalities: The Story of Stuff with Annie Leonard

6. Market Failure Types of market failure How is the global financial crisis a result of a market failure? Information Asymmetry: When the consumers or producers of a particular good or service, (or financial asset) make their decisions based on imperfect information. Information asymmetry in the financial markets: A crash course! ·Americans bought homes in growing numbers in the '90s and early 2000s under the assumption that house prices would always rise. Banks made loans to Americans who normally wouldn't qualify for loans under the same assumption. ·Banks "bundled" these loans into securities that they sold to investors all over the world, who assumed that the lending banks were correct in their assumption that house prices would continue to rise. ·Developers built houses in record numbers based on the assumption that they'd be able to sell them at higher and higher prices. ·Supply of houses grew faster than demand, and eventually house prices began to fall. ·Borrowers found they could not make their monthly payments because their loans were "adjustable rate" meaning they required higher payments over time, causing foreclosures to increase and the supply of houses for sale to grow even more, forcing prices down even more. ·Now investors and banks all over the world hold securities made up of bad loans to Americans that were made based on the incorrect assumption that house prices would always rise. With bad assets on their "balance sheets" banks are unable to make new loans to consumers and firms, so spending in the economy has slowed, meaning recession and high unemployment. Imperfect information about the true value of houses led to an over-allocation of the world's financial resources towards the US housing market!

7. Market Failure Public Goods What are three goods or services from which you have benefited in the last year that were provided by the free market? Three goods that were not? Private goods: ·________________ ·________________ ·________________ Public goods: ·_________________ ·_________________ ·_________________ Private goods are: ·Rivalrous in consumption: When I purchase and use an iPod, it is not available for another person's purchase and consumption. ·Excludable by seller: Apple can keep people who do not pay for an iPod from obtaining its benefits. Only people who are willing to pay for an iPod can enjoy its benefits. Because of their rivalry and excludability, firms in a free market find it profitable to produce and sell private goods.

8. Market Failure Public Goods Public goods:or social goods would not be produced through the market, because they are non-rivalrous and are not subject to the exclusion principle. Public goods are: ·Nonrivalrous:one person's consumption of a good does not prevent others from consuming it too. ·Nonexcludable:once the good comes into existence (it is produced), it is impossible from excluding certain individuals from benefiting from it. These characteristics create the free-rider problem.No one will voluntarily pay for a product or service they could just as easily consume without paying for. Since firms cannot effectively "tap the market demand", they will simply not produce public goods. Resources are reallocated from private to public use by levying taxes on households and businesses government uses tax revenue to provide the public goods, correcting the market failure. Blog posts: "Public goods"

9. Market Failure Public Goods Below are a selection of goods or services you may have "consumed" recently. ·Which are "private goods", i.e. rivalrous and excludable? ·Which are "public goods", i.e. nonrivalrous and nonexcludable? Private goods Public goods

10. Market Failure Public Goods Demand for public goods: NATIONAL DEFENSE - Every individual in society may have a different demand for national defense. ·Jimmy may be willing to spend $200 a year for one tank to provide military protection. ·Jenny, a pacifist, may only be willing to pay $50 a year to build tanks. If Jimmy and Jenny are the only two people in the country, then the total willingness to pay for 1 tanks for military protection is only $250. The government will clearly not be able to provide even one tank. However, since there are millions of people like Jimmy and Jenny, society's total willingness to pay for military protection is significantly greater than $250. Quantity of tanksSociety's Marginal Benefit (millions)Marginal Cost of tanks (millions) 100 $250 $35 200 $190 $55 300 $130 $90 400 $70 $145 500 $30 $210 Marginal Social Benefit and Marginal Social Cost: ·As the number of tanks increases, the society's marginal benefit from additional tanks declines. This is due to thelaw of diminishing marginal utility ·As the number of tanks increases, the marginal cost to society of producing more tanks increases. This is due to thelaw of diminishing returns

11. Market Failure Public Goods What is the optimal quantity of tanks for the government to provide? B/C To determine the optimal quantity of tanks, the government should compare society's marginal benefit (demand for tanks) to the marginal cost of providing tanks (the supply of tanks). The government should provide tanks up to the point where the marginal benefit equals the marginal cost. Marginal social cost 250 225 200 175 150 125 100 75 50 25 Marginal social benefit Q 2 5 3 1 4 Conclusion: firms in a free market would provide ZERO tanks for military protection, since their benefits are non-rivalrous and non-excludable. Therefore, the government should do so, up to the point where the MB to society equals the MC to society. Practice Public Goods: NCEE workbook Activities 52 and 53

12. Market Failure Public Goods Private vs. Public - the never-ending debate! Move the following goods or services to where they belong along the spectrum. Rivalrous/Exclusive Shared/Nonexclusive Purely Private Quasi-public Purely Public Elementary schooling Health care National rail line National Defense Professional sports events Water College education Postal service Groceries Interstate highway facilities Cable TV Garbage collection Park benches Radio Recreational facilities Police protection Electric power Based on the outcome of the activity above, which goods should be provided by government, which by the free market and which are uncertain? Free market? Uncertain? Government? What are the implications for government, for politicians, for households and businesses of your conclusions? What makes the provision of public goods such a sensitive political topic?

13. Market Failure The Tragedy of the Commons The Tragedy of the Commons: an Essay by Garrett Hardin, 1968 The tragedy of the commons develops in this way. Picture a pasture open to all. It is to be expected that each herdsman will try to keep as many cattle as possible on the commons. Such an arrangement may work reasonably satisfactorily for centuries because tribal wars, poaching, and disease keep the numbers of both man and beast well below the carrying capacity of the land. Finally, however, comes the day of reckoning, that is, the day when the long-desired goal of social stability becomes a reality. At this point, the inherent logic of the commons remorselessly generates tragedy. As a rational being, each herdsman seeks to maximize his gain. Explicitly or implicitly, more or less consciously, he asks, "What is the utility to meof adding one more animal to my herd?" This utility has one negative and one positive component. 1) The positive component is a function of the increment of one animal. Since the herdsman receives all the proceeds from the sale of the additional animal, the positive utility is nearly +1. 2) The negative component is a function of the additional overgrazing created by one more animal. Since, however, the effects of overgrazing are shared by all the herdsmen, the negative utility for any particular decision-making herdsman is only a fraction of -1. (Welker's thoughts: as we know, rational beings humans base all decisions on marginal benefit / marginal cost analysis. For this herdsman, the marginal benefit of grazing one more animal will always exceed the marginal cost since the cost is shared by all herdsemen, but the benefit accrues only to himself) Adding together the component partial utilities, the rational herdsman concludes that the only sensible course for him to pursue is to add another animal to his herd. And another; and another.... But this is the conclusion reached by each and every rational herdsman sharing a commons. Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit--in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all.

14. Market Failure The Tragedy of the Commons Examples of "the Commons" Public land and the open seas Even at this late date, cattlemen leasing national land on the western ranges demonstrate no more than an ambivalent understanding, in constantly pressuring federal authorities to increase the head count to the point where overgrazing produces erosion and weed-dominance. Likewise, the oceans of the world continue to suffer from the survival of the philosophy of the commons. Maritime nations still respond automatically to the shibboleth of the "freedom of the seas." Professing to believe in "the inexhaustible resources of the oceans," they bring species after species of fish and whales closer to extinction (9). The National Parks present another instance of the working out of the tragedy of the commons. At present, they are open to all, without limit. The parks themselves are limited in extent--there is only one Yosemite Valley--whereas population seems to grow without limit. The values that visitors seek the parks are steadily eroded. Plainly, we must soon cease to treat the parks as commons or they will be of no value anyone. What shall we do? We have several options. We might sell them off as private property.We might keep them as public property, but allocate the right enter them. The allocation might be on the basis of wealth, by the use of an auction system. It might be on the basis merit, as defined by some agreed-upon standards. It might be by lottery. Or it might be on a first-come, first-served basis, administered to long queues. These, I think, are all the reasonable possibilities. They are all objectionable. But we must choose--or acquiesce in the destruction of the commons that we call our National Parks.

15. Market Failure The Tragedy of the Commons Examples of "the Commons": The air we breath and the water we drink In a reverse way, the tragedy of the commons reappears in problems of pollution. Here it is not a question of taking something out of the commons, but of putting something in--sewage, or chemical, radioactive, and heat wastes into water; noxious and dangerous fumes into the air, and distracting and unpleasant advertising signs into the line of sight. The calculations of utility are much the same as before. The rational man finds that his share of the cost of the wastes he discharges into the commons is less than the cost of purifying his wastes before releasing them. Since this is true for everyone, we are locked into a system of "fouling our own nest," so long as we behave only as independent, rational, free-enterprises. The tragedy of the commons as a food basket is averted by private property, or something formally like it. But the air and waters surrounding us cannot readily be fenced, and so the tragedy of the commons as a cesspool must be prevented by different means, by coercive laws or taxing devices that make it cheaper for the polluter to treat his pollutants than to discharge them untreated. We have not progressed as far with the solution of this problem as we have with the first. Indeed, our particular concept of private property, which deters us from exhausting the positive resources of the earth, favors pollution. The owner of a factory on the bank of a stream--whose property extends to the middle of the stream, often has difficulty seeing why it is not his natural right to muddy the waters flowing past his door. The law, always behind the times, requires elaborate stitching and fitting to adapt it to this newly perceived aspect of the commons. The pollution problem is a consequence of population. It did not much matter how a lonely American frontiersman disposed of his waste. "Flowing water purifies itself every 10 miles," my grandfather used to say, and the myth was near enough to the truth when he was a boy, for there were not too many people. But as population became denser, the natural chemical and biological recycling processes became overloaded, calling for a redefinition of property rights.

16. Market Failure The Tragedy of the Commons Discussion Questions: 1. What is Garret Hardin most concerned about? 2. How can "the commons" best be defined? 3. Are individuals who overuse "the commons" acting irrationally? Explain. 4. Besides the "common pasture", what other resources does Hardin identify as "commons"? 5. What are some of the possible solutions he suggests for the problems faced by America's National Parks? 6. How are air and water different from pastures, the oceans, and national parks in the "tragedy" presented by the common resources? 7. What are some of the possible solutions Hardin suggests for the "cesspool" tragedy represented by the pollution of our air and water? 8. What do you think a hard-core, free-markete economist would say is the solution to "the tragedy of the commons"?

17. Market Failure Negative Externalities Negative externality: A negative externality occurs anytime an individual or a group that plays no part in a market transaction is negatively affected by bearing some of the costs of someone else's transaction. "The Middle of Nowhere".mp3 Questions on audio: 1) What is the "tragedy of the commons" as portrayed in this story? 2) What is the market failure present in the story? 3) Why is it impossible to get anyone to do anything about the problem? Cause of negative externalities:Over-allocation of resources towards products that have spillover costs associated with either their production or consumption. Consumption: Unertain? Production: traffic water pollution cigarette smoke airport noise drunk driving air pollution fast food acid rain body oder over-fishing global warming nuclear waste Effects: spillover costs born by groups external to the market transaction (sometimes society as a whole).

18. Market Failure Negative Externalities of production Graphical portrayal of a negative externality of production. D=MSB: Marginal social benefit. This represents the amount of output demanded by society at different prices. Due to diminishing utility, society's marginal benefit declines the more output is provided. Polluting industry S=MSC B/C S=MPC distance b/w MPC & MSC = external costs S=MPC: Marginal private cost. Because the producer is able to externalize some of its costs, its MC is lower than it would be were it to bear all the costs of production. Cso Ce S=MSC: Marginal social cost. Since some of the costs of production are externalized, they are ultimately born by society. The cost to society is greater than the cost to the individual firm. DWL D=MSB Qe > Qso: Equilibrium quantity is greater than the socially-optimal quantity. Represents overallocation of resources towards this product. Q Qso Qe Qe > Qso: resources are over-allocated towards the polluting industry

19. Market Failure Negative Externalities of production Government solution to negative externality of production:CORRECTIVE TAX! Corrective taxes: can be levied on polluters. ·The tax payment will increase costs to the producer, shifting the product supply curve leftward, and reducing resource allocation to this type of production as desired. ·Notice that in the case of a tax, the burden is not placed entirely on the sellers, rather it's shared by consumers and producers of the harmful product. ·The challenge to policymakers is to set the level of the tax as close as possible to the amount of the costs externalized by the firm on society. ·The result is a higher price paid by consumers, lower quantity demanded, and tax revenue for the government. Fewer resources are allocated towards the polluting industry after the tax. Polluting Industry S+tax=MSC P S=MPC Pb-Ps= amount of tax Pb C Pe P Ps D=MSB Q Qso Qe C = consumer tax burden P = producer tax burden

20. Market Failure Negative Externalities of production Alternative to corrective taxes: DIRECT GOVERNMENT CONTROLS Direct controls: Governments may choose to legislate pollution control. Requiring firms to limit their emissions of harmful pollutants presents challenges of its own. ·Monitoring: The government must monitor emissions of polluters, which can be costly and difficult. ·Enforcement: The government must have a way to enforce legislation on polluters. ·Penalties: The penalties for violations must be significant enough to dissuade firms from ignoring legislation ·Incentives: If the penalty is not harsh enough, the firm will simply ignore regulations and pollute anyway. The fine must be greater than the cost of pollution abatement, otherwise firms will keep polluting.

21. Market Failure Negative Externalities of production Alternative to corrective taxes: DIRECT GOVERNMENT CONTROLS Polluting Industry Swith abatement costs The intended effect of direct government control is to force the polluters to incur costs associated with pollution control. Firms forced to reduce their pollution will face higher costs, shifting the market supply curve for a polluting product to the left. Equilibrium quantity should fall closer to the socially optimal level. P S=MPC Pb-Ps=cost of pollution abatement Pb Pe D=MSB Q Qso Qe Clean air and water legislation and "CAFE" standards are examples. Corporate Average Fuel Economy - Wikipedia Clean Water Act - Wikipedia Clean Air Act - Wikipedia

22. Market Failure Negative Externalities of production Discussion Question: Why doesn't the government simply ban the production and consumption of all goods that cause negative externalities? What are two alternatives to a complete ban a government can use to correct such a market failure? Give an example of each. Example of direct government control:the "CAFE" standards: "The Corporate Average Fuel Economy (CAFE) regulations in the United States, first enacted by Congress in 1975, are federal regulations intended to improve the average fuel economy of cars and light trucks (trucks, vans and sport utility vehicles) sold in the US in the wake of the 1973 Arab Oil Embargo." -from Wikipedia Alternatives to direct government controls: Blog post: "When more tax is a good tax" Blog post: "Reducing negative externalities – the European market for carbon emissions"

23. Market Failure Negative Externalities of production The latest, most innovative method for combating pollution and global warming isa market for pollution rights. Carbon Market How it works: ·A government or multi-national governing body issues or auctions off permits to polluting industries which allow them to emit a certain amount of carbon. ·Some firms pollute beyond their permitted amount, so will either have to acquire more permits or reduce their emissions. ·To acquire more permits, they must buy them from in the market from firms that do not need all of their permits. ·The supply of permits is fixed and determined by the government, the demand for permits therefore determines the price of pollution. The more firms want to pollute, the more expensive it becomes to pollute. ·There is a strong incentive for firms to reduce their emissions, because they can then sell the permits they do not need, adding to firm profit. S2012 S2008=supply of carbon emmissions permits(determined by officials based on environmental studies) P2012 Price per pollution right P2008 D2012 D2008 Q2008 Q2012 Quantity of pollution rights "Tighter European limits set to push up price of carbon emissions" "Price of carbon in Europe is expected to rise"

24. Market Failure Negative Externalities of production Tradeable pollution permits, how they work: ·A pollution-control agency decides the acceptable amount of pollution in a particular region and creates rights that firms can purchase to allow them to pollute. Each right will allow a certain amount of pollution. The total supply of rights is perfectly inelastic ·The demand for pollution rights should be downward sloping. At high prices, firms will either stop polluting or pollute less by acquiring pollution-abatement equipment, which is more attractive when the rights are more expensive. ·With the given supply of rights, and a demand for rights, an equilibrium price will be established for each right to pollute. Carbon Market S=supply of pollution rights (determined by officials based on environmental studies) P2018 Price per pollution right P2008 D2018 D2008 Qso Quantity of pollution rights There are several advantages to this system: ·It reduces society’s costs because pollution rights can be bought and sold. Some firms will find it cheaper to buy the rights than to acquire abatement equipment; other firms can sell their rights because they may be able to reduce pollution at a lower cost. ·Conservation groups as well as producers can buy rights. If conservation groups are unhappy with the existing amount of pollution, they can acquire pollution rights and hold them. Drives up the price of remaining rights, further encouraging polluters to reduce emissions. ·The revenue from the sale of pollution rights could be used to improve the environment. ·The rising cost of pollution rights should lead to improved pollution-control techniques.

25. Market Failure Positive Externalities of consumption Definition of positive externality of consumption: Exists when the consumption of a good or service leads to benefits to society that are greater than the benefits to the individual consuming the good or service. Examples: ·vaccinations: when anyone receives a vaccine, everyone benefits b/c of the reduced likelihood of a disease spreading. ·education: if you receive a college education, the people around you will benefit because you will be a more productive member of the economy. As more people receive educations, more uneducated people benefit as the workforce as a whole becomes more productive and society becomes richer. ·condoms: (probably not in your textbook), for the same reason as vaccinations, basically. ·healthy school lunches: healthier kids means less demand for thus lower health care costs, good for all of society! the list goes on and on... sometimes good that create positive externalities are called"MERIT GOODS". Merit is defined as "something that deserves or justifies a reward or commendation" Cause of positive externalities: Underallocation of resources towards products that have spillover benefits associated with either their consumption.

26. Market Failure Positive Externalities of consumption Graphical portrayal of positive externalities of consumption D=MPB: Represents the private benefit an individual receives from the consumption of a "merit good". Market for college education B/C S=MSC MPB is less than D=MSB, since society as a whole benefits more than the individual alone from the consumption of the merit good. Bso S=MSC: Represents the marginal cost of producing the merit good. Since most merit goods create spillover costs from their consumption, we are only concerned here with the social cost (there is no difference between MSC and MPC as in the case of negative externalities. Be DWL D=MSB D=MPB Qso - Qe: Represents the underallocation of resources towards the merit good. Q Qso Qe

27. Market Failure Positive Externalities of consumption Goods which create positive externalities of consumption represent a market failure because resources will be UNDER-allocated towards these goods if the free market is left to itself. Pos. Ext of Consumption P Government response to the existence of positive externalities: MSC Subsidies to producers: lower costs to producers of the merit good. Lower costs shift market supply out, lowering the price to consumers and increasing quantity demanded. Subsidies to consumers: Government may help pay for part of a merit good, increasing demand Government provision: Government pay chose to provide merit goods. P1 Pe MSB MPB Q Qso Qe Resources are underallocatedwhen there's a positive externality Merit goods vs. Public goods, what's the difference?A merit good will be provided by the free market, just under-provided. A public good will not be provided by the free market thus must be provided by government!

28. Market Failure Positive Externalities of consumption Using subsidies, the government can correct the market failure of too few resources being allocated towards merit goods Market for college education (subsidize universities) S P S+subsidy size of subsidy Subsidize consumers: Shift demand curve out, increasing price, but the price increase would not be born by consumers, rather, the government. Ps D+subsidy Subsidize producers: Would shift S out, increasing output and lowering price. D=MPB Government provision:Some merit goods may just be provided by the government, if the free market fails to provide them. These are public goods. Q Qso Examples: ·free and reduced lunches ·subsidized student loans ·free flu shots ·free condoms at some public schools

29. Market Failure Positive Externalities of consumption Discussion Questions: What is the difference between a negative externality and a positive externality? If positive externalities are so positive, what makes them a market failure? If taxes can be used to correct a negative externality, what type of government measure can be used to correct a positive externality? Positive externality of consumption: When one person's consumption of a particular good or service has positive spillover effects on those around them or on society as a whole. The marginal social benefit of consumption exceeds the marginal private benefit. Examples: vaccines, education, flower gardens, driver's training courses, hybrid cars, bicycles, renewable energies, Others? Goods that create positive externalities and are under-provided by the market are called MERIT GOODS

30. Market Failure Negative Externalities of consumption Negative externalities of consumption exist when the consumption of a particular good by one individual places spillover costs on others who do not participate in the original transaction. MPB:the benefit to the individual of consuming the good. MSB: the benefit to society of derived from the consumption of the good. MPB>MSB: the individual consumer benefits more from the consumption of a good than society as a whole. There are spillover costs of consumption not experienced by the consumer himself. Since consumers base their decisions on their own self-interest, Qe will be consumed, which is greater than Qso, the socially optimal quantity. Negative Ext of Consumption C/B MSC Be DWL Bso D=MPB D=MSB Qso Qe Q Resources are over-allocated towards goods that create negative externalities of consumption. These are called "demerit goods"

31. Market Failure Negative Externalities of consumption Government solution to negative externality of consumption:CORRECTIVE TAX! Corrective tax shifts the market supply to the left, increasing the equilibrium price, and reducing the quantity demanded by consumers to the socially optimal level. Negative Ext of Consumption P S+tax S=MSC P1 Pe Examples: ·Alcohol taxes ·Cigarette taxes ·Petrol taxes ·Garbage bags in Zurich ·Plastic bags at grocery stores D=MPB D=MSB Qso Qe Q Blot posts: "Externalities"

32. Market Failure Negative Externalities of consumption Gov't solution to negative externality of consumption:Negative advertising Negative Ext of Consumption P Negative advertisingcan be used to decrease the marginal private benefit to consumers of the good. If MPB falls it will be closer to the MSB, resulting in a more efficient allocation of resources. Examples: ·"Don't drink and drive" campaigns ·Anti-smoking campaigns ·Drug awareness programs ·Harsh punishments for drug and alcohol violations S=MSC=MPC Pe D=MPB D=MSB Qso Qe Q

33. Tax Incidence and Deadweight Loss When does an excise tax create a loss of welfare to society? When the good being taxed was already being produced at the socially optimal level! When does an excise tax create an improvement in welfare? When the good being taxes was being over-produced by the free market. S+tax=MSC S+tax Market for De-merit good Market for a normal good P P MPC = MSC MPC Pso Pt Pe Pe DWL MSB MSB Q Qe Q Qe Qso Qt

34. Tax Incidence and Price Elasticity of Demand The government has decided to place a tax (let's say $5) on a product to reduce its consumption and to raise revenues. Questions: 1) In which market will consumption be reduced the most by the tax? 2) In which market will consumers bear the largest burden of the tax? 3) Producers?4) In which market will the most revenue be raised by the tax? 5) What conclusions can you make about the relationship between PED and tax incidence? S+tax S+tax Cigarette Market Luxury Handbag Market P S P S Blue rectagles= consumer tax burden Green rectangles= producer tax burden Pb Pb Ps Ps D D Q Qt Qe Q Qt Qe

35. Tax Incidence and Price Elasticity of Supply The government has decided to place a tax (let's say $5) on a product to reduce its consumption and to raise revenues. Questions: 1) In which market will consumption be reduced the most by the tax? 2) In which market will consumers bear the largest burden of the tax? 3) Producers?4) In which market will the most revenue be raised by the tax? 5) What conclusions can you make about the relationship between PES and tax incidence? S+tax Market for Christmas Trees P Market for Basketball Shoes P S S+tax S amount of tax Blue rectagles= consumer tax burden Green rectangles= producer tax burden D D Q Q