# 1 G406, Regulation, Eric Rasmusen, April 26, 2012 REVIEW.

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1 G406, Regulation, Eric Rasmusen, erasmuse@indiana.edu April 26, 2012 REVIEW

Graphing the Market 2

Only Quantity Matters Whatever price is chosen under this two-part regulation, the total surplus will stay the same. When the quantity is xed, the price is just a transfer from buyer to seller. The total surplus is ( Gross Buyer Beneƒit -Price Quantity) + ( Price Quantity - Seller Cost). The Price Quantity terms cancel each other, so the total surplus is (Gross Buyer Benet - Seller Cost), which does not depend on the price. 3

The Marginalism Argument The total surplus does depend on the quantity, however, which we were keeping xed at 200,000 bottles. To see why this quantity maximizes surplus, consider increasing it. We will need the most reluctant seller to become active, one whose value for a bottle is \$10.00 and who has already sold some but not all of his 100 bottles, since sellers with lower values are already selling. We will need a new buyer to become active too, one whose value is less than \$10.00, since buyers with higher values are already buying. Even if the new sellers value is \$10.00 and the new buyers value is \$9.99, this new exchange reduces total surplus by \$.01 rather than increasing it. Increasing sales further would reduce total surplus by even more. 4

A Price Ceiling (rent control) 5

6 Monopoly Allocative Inefciency

Value Curves lk; If consumers have good information, then their maximum willing- ness to pay is also their true value of the product. Their demand curve their maximum willingness to pay is the same as their value curve the value they receive from the product once they consume it, given their personal tastes and the other things they are consuming.

Externalities lk; 8

A Pollution Tax 9

Real versus Pecuniary Externalities The shattered whisky bottle, the water pollution, and the tree in the yard create real externalities: spillovers such that someones action affects the utility of someone else directly rather than through prices. If the spillover results from prices changing, it is called a pecuniary externality. 10

The Barbers Guild 11

A Price Floor lk; 12

Three Categories of Public Servants Elected officials such as the United States President. Bureaucrats who are appointed by the elected officials and who can be fired by them, e.g., the Secretary of the Treasury. Bureaucrats who spend most of their careers in government service (e.g., FBI agents) 13

Three Types of Officials 1. Careerist. Their loyalty is to the agency. 2. Politician. Their loyalty is to whoever can promote them. 3. Professional. Their loyalty is to their profession. All three would like to do a good job, but for different reasons. All three can be either political appointees or civil servants. 14

The Three-Part Test for Regulation 1. Is there market failure? 2. Is there a regulation that would solve the market failure better? 3. Would there be government failure if we tried to pass the regulation? 15

Making Regulations: Administrative Law A regulation is like a law, but Congress doesnt have to approve it. Every regulation is supposed to be a mere implementation of a Congressionally-passed law. If Congress passes a law that says dangerous substances must be kept to safe levels in the workplace, the executive branch must decide how much to limit benzene, if at all. This gives a lot of power to the President. 16

The Chevron Doctrine If a regulation has gone through the formal process and someone questions in court whether the regulation is a correct application of the statutes, the courts give the benefit of the doubt to the regulation. This is known as administrative deference, or the Chevron Doctrine. 17

The Two-Part Test ``If the intent of Congress is clear, that is the end of the matter; for the court as well as the agency must give effect to the unambiguously expressed intent of Congress. If the Court determines Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction of the statute... rather,… If the statute is silent or ambiguous with respect to the specific question, the issue for the court is whether the agency's answer is based on a permissable construction of the statute.'' 18

The Home Concrete Case What should be the statute of limitations for reporting too low a number for your capital gains profit?– Three years, like most things; or six years, like omissions from income Since the 1950s everybody has thought that if you include but misreport your capital gains, the limit is 3. Recently, the IRS has claimed 6. The IRS lost 13-0 in Tax Court. Then it passed a new regulation saying its 6 years. Then on appeal, it pointed to the new regulation and claimed Chevron deference. The Supreme Court heard oral argument Jan.2012. 19

Present discounted value 20 The present discounted value or present value of X dollars received t years from today is, if the discount rate is constant at r: The value of of X dollars received t years from today is, if the discount rate varies each year: The present value of X dollars at the end of each year forever, the bond known as a perpetuity or a consol is :

The Time t to Double Your Initial Investment X 21

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Two Methods 23 1. The Forensic Approach Look at the value of earnings and services that could be bought for dollar amounts, e.g. a man has 10 years of working life left, he earns \$50,000/year, and interest rates are zero, so his life is worth \$500,000. 2. The Statistical Life Approach Look at how much people accept to bear small risks of death and scale that up, e.g. We would each pay \$20 to avoid a 1/1000 chance of death this year, so as a group, 1000 of us would pay \$20,000 to avoid the certainty of one of us dying this year.

Hedonic Regression 24

Supply and DemandTax Example 25

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Setting the Minimum Wage 29 What is the supply curve for workers labor?

Setting the Minimum Wage 30

The Minimum Wage and Recession 31

The Workers Ideal if Qd=18-L 32

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Health Insurance as an Efficient Fringe Benefit 34 by workers by employers

Inefficient Fringe Benefits 35 by employers by workers

Unperceived Workplace Danger 36

Job Danger: Downward Sloping Demand 37

Bank Runs 38

LEVERAGE RAISES PROFITS: Riskless Arbitrage 39

Risky Arbitrage (corrected for bankruptcy) 40 Return:.8(610%) +.2 (-100%) = 488%- 20%= 468%.

Tranches: Creating Safe Assets Out Of Risky Ones 41

Licensing vs. Regulation 43

A Pollution Tax 44

A Pollution Tax with Rising Supply 45

Optimal Pollution 46

Two Firms and Cap and Trade 47

A Coase Theorem Example 48 A paper mill is polluting a river. The farmer downstream had been selling trout fishing rights to rich tourists for \$20,000. Now the trout have fled, and he gets zero. The factory could install filtering machinery that would eliminate the pollution, at a cost of \$4,000. 1. Suppose the farmer has the right to a clean river. 2. Suppose the factory has the right to dump its waste water into the river.

First Problem: The Common Pool Resource Game 49

Shifts in Supply as the Resource Runs Out 50

The Price of a Nonrenewable Resource over Time 51

Licensing vs. Regulation 53

A Pollution Tax 54

A Pollution Tax with Rising Supply 55

Optimal Pollution 56

Two Firms and Cap and Trade 57

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