1. Government Policy & Economic Welfare
Econ 201 Lecture
Government Policy &
Economic Welfare

2. Evaluating the Impact of Government Intervention
Policy Instruments Available
Taxes
Typically: per-unit tax on output
Others: lump-sum, value added (VAT)
Subsidies
Rebate on per-unit produced
Price Floors
Minimum price that can be charged (e.g., minimum wage)
Price Ceilings
Limit on the maximum price that can be charged (WIN)
Quotas
Limits on amounts produced/imported
Infant industry/protectionism

3. How Do We Analyze the Effects of Taxes and Subsidies
The efficient ideal market
“perfectly competitive” market
Consumers and suppliers are price-takers, i.e. have no market power

4. Total Social Welfare
Ideally the impact of a program should be evaluated as: {Pareto efficient}
1) can at least one person’s welfare be improved
2) without making anyone worse off
More realistically: Could the winners compensate the losers? {Pigouvian}
Is the deadweight loss of the taxed good less than the surplus gain from the subsidized good?

5. Application: Taxes and Competitive Equilibrium
Consider a per-unit tax, which adds a fixed dollar amount to each unit of a good sold.
Graphically, the imposition of the tax is shown by a leftward shift of the supply curve.

6. Figure 6.4 The Effect of a Per-Unit Tax on Laptop Sales

7. Deadweight Loss Price Consumers Pay Pre-tax price Price Sellers
Receive
Reduction in
Qty sold

8. Deadweight Loss Retained CS Tax Rev From CS Tax Rev From CS
Retained PS

9. Application: Taxes and Competitive Equilibrium
This example illustrates three key ideas related to taxes:
Incidence of a tax on consumers:
The increase in price that consumers pay
Incidence of a tax on producers:
The decrease in price producers receive
Deadweight loss:
Losses in consumer and producer surplus that are not transferred to the government as revenue

10. Elasticity and Tax Incidence
The incidence of a tax will be determined by the elasticities of demand and supply.

11. Figure 6.5(a) Elasticity and Tax Incidence

12. Figure 6.5(b) Elasticity and Tax Incidence

13. Tax Incidence and Demand Elasticity
If demand is inelastic, the majority of the tax incidence falls on consumers.
If demand is elastic, the majority of the tax incidence falls on producers.
As demand elasticity increases, the deadweight loss increases.

14. Figure 6.5(c) Elasticity and Tax Incidence

15. Figure 6.5(d) Elasticity and Tax Incidence

16. Tax Incidence and Supply Elasticity
If supply is inelastic, the majority of the tax incidence falls on producers.
If supply is elastic, the majority of the tax incidence falls on consumers.
As supply elasticity increases, the deadweight loss increases.

17. Quotas
Quota—A maximum quantity of a good or service that can be traded over a specific period of time.
Used when the government determines the equilibrium quantity would not be in society's best interest
For example: International trade

18. Figure 6.9 The Effect of a Quota on the Market for Laptop Computers
MV to Consumers
DWL from CS
DWL from PS
MC of resources
Quota Restriction
Equilibrium Qs

19. The Effects of a Quota Quotas result in:
A transfer of surplus from consumers to producers
Deadweight loss (DWL)
DWL is due to less being produced than would be in an unrestricted (competitive) market
Resources are underutilized and inefficiently allocated
Consumers place a higher MV on good than MC of using resources to produce the good

20. The UW and Quotas
The UW has recently announced that it will not accept any transfers for spring quarter
Restriction on number of students being admitted <-> quota
Assume that the market had previously been efficient (Qs= Qd at current tuition fee)
A) what would be the economic consequences of the transfer “freeze”?
B) what would be the impact of raising tuition, instead of “freezing” transfers
C) In real-life, how are the students admitted to the UW determined (by what kind(s) of allocation schemes?

21. Another Quota Problem
It is estimated that illegal immigrants account for about 25% of construction labor in the US housing market
A) what would be the impact a ban on illegal immigrants on the labor market for US housing construction, i.e., hourly wage rates?
B) what would be the impact of this ban on the price of newly constructed houses?