introduction o micro economics chapter .ppt

introduction o micro economics chapter

1. The Role of Government
Chapter 14
LIPSEY & CHRYSTAL
ECONOMICS 12e

2. Learning Outcomes
•Governments have objectives for stability, growth,
and equity, as well as for efficiency
•Equity, efficiency, and growth objectives may
often conflict
•Tools of government policy include taxation and
spending, the law, and regulation, as well as
public production of goods and services

3. Learning Outcomes
•Government interventions usually involve both
direct costs of administration and indirect costs
associated with interference with the price
mechanism.
•The incentives facing specific governments may
deviate from those needed to deliver economic
efficiency.

4. Government Objectives
•Governments seek to protect life and property,
improve economic efficiency, protect individuals from
others and [sometimes] from themselves, influence
the rate of economic growth, and stabilize the
economy against fluctuations in national income and
the price level.
•Policies for equity include making the distribution of
income and wealth somewhat less unequal.
INTRODUCTION -THE ROLE OF GOVERNMENT

5. Government Objectives
•Equity, efficiency, and growth often come into
conflict.
•Policies to increase equity can reduce efficiency
and/or growth, while policies to increase efficiency or
growth can make some situations less equitable.
INTRODUCTION -THE ROLE OF GOVERNMENT

6. Tools and Performance
•Governments may seek to achieve their policies using
the tools of taxes, expenditure, rules and regulations,
and public ownership.
INTRODUCTION -THE ROLE OF GOVERNMENT

7. TheCostsofGovernmentIntervention
•Governmentactivityincursmanytypesofcost.Internal
costsrefertothegovernment’sowncostsof
administeringitspolicies.
•Directexternalcostsrefertothecostsimposedonthose
directlyaffectedbythesepoliciesinsuchtermsasextra
productioncosts,costsofcompliance,andlossesin
productivity.
•Indirectexternalcostsrefertotheefficiencylossesthat
spreadthroughoutthewholeeconomyasaresultofthe
alterationinpricesignalscausedbygovernmenttaxand
expenditurepolicies.
INTRODUCTION -THE ROLE OF GOVERNMENT

8. GovernmentFailure
•Aswellasshowingthepotentialforbenefitsto
exceedcostsinaworldwherethegovernment
functionedperfectly,itisnecessarytoconsiderthe
likelyoutcomeintheimperfectworldofreality.
INTRODUCTION -THE ROLE OF GOVERNMENT

9. GovernmentFailure
•Governmentfailure-notachievingsomepossible
gains-canarisebecauseofrigiditiescausinga
lackofadequateresponseofrulesandregulations
tochangingconditions,poorerforesightonthepart
ofgovernmentregulatorscomparedwithprivate
participantsinthemarket,andgovernment
objectives-suchaswinningthenextelection-that
conflictwithobjectivessuchasimprovingeconomic
efficiency.
INTRODUCTION -THE ROLE OF GOVERNMENT

10. Income Taxes With Different Progressivities -Proportional
10
25
20
5
10
15
Income [000]
20 30
Income [£000]
30 [i]. Proportional

11. Income Taxes With Different Progressivities -Progressive
30
25
20
5
10
15
[2]
[1]
10 20 30
Income [£000]
[ii]. Progressive

12. Income Taxes With Different Progressivities -Regressive
Income [000]
30
25
20
15
10
5
10 20 30
[3]
[4]
[iii]. Regressive
Tax paid [£000]

13. Part (i):
This proportional tax’s average and marginal rates remain
unchanged at 50 per cent as income changes.
Income Taxes With Different Progressivities

14. Part (ii):
Tax (1) has a constant marginal rate of 50 per cent.
But the average rate rises with income, being zero at income
£10,000, 25 per cent at income £20,000, and 33 per cent at
income £30,000.
With tax (2) both the marginal and the average tax rates rise
as income rises.
Income Taxes With Different Progressivities

15. Part (iii):
Tax (3) has a constant marginal rate of 50 per cent.
But the average rate falls as income rises, being 150 per cent
at £10,000, 100 per cent at £20,000, and 83.3 per cent at
£30,000.
With tax (4) both the marginal and the average rates fall as
income rises.
Income Taxes With Different Progressivities

16. E
0
S
1
q
0
D
0
Quantity
The Inefficiency of Free Goods
2
q
1
p
0

17. Competitive equilibrium is at E
0.
Price is p
0, and quantity q
0.
At a zero price q
1is consumed.
Since each extra unit that is produced adds its marginal cost to the
total cost of production, total costs rise by the area under the
industry’s marginal cost curve (its supply curve).
The two shaded areas 1 and 2 show this extra cost of production.
The additional consumers’ surplus is given by the medium blue
shaded area 1.
So the efficiency loss is the dark shaded area 2.
The Inefficiency of Free Goods

18. Quantity
0
The Efficiency Loss From an Indirect Tax

19. q
0
p
0
E
0
Quantity
S
D
0
The Efficiency Loss From an Indirect Tax

20. q
0
E
0
Quantity
S
D
0
Tax
The Efficiency Loss From an Indirect Tax
p
0

21. E
1
E
0
Quantity
Tax
S
1
S
D
The Efficiency Loss From an Indirect Tax
p
0
p
0
p
0
0
q
1q
0

22. The original curves are Sand D.
Equilibrium is at E
0with price p
0and quantity q
0.
The tax shifts the supply curve to S
T.
Equilibrium moves to E
1 .
Market price is p
1, and quantity q
1.
Consumers pay p
1, while the after-tax receipts of producers
are p
2.
The Efficiency Loss From an Indirect Tax

23. The government gains tax revenue equal to the light yellow
area, which is p
1minus p
2multiplied by q
1.
Part of this revenue comes from producers and part from
consumers.
Consumers also lose surplus of the dark yellow area.
Producers also lose surplus of the medium shaded area.
Since no one gets the surpluses that consumers and
producers lose, they are the deadweight losses of the tax.
The Efficiency Loss From an Indirect Tax

24. Daily income [£]
E
1
G
E
0
E
2
840 960480320240120
24
20
18
16
15
10
5
0
An Income Tax and the Work-leisure Choice

25. This person earns £40 an hour.
His budget line runs from 24 hours (no work) to £960 (no sleep!).
He maximizes utility at E
0.
Here he takes 16 hours of leisure and works 8 hours to gain an
income of £320 per day.
Income tax:An income tax of 50 per cent shifts his after-tax
budget line to run from 24 hours to £480 (no sleep!)
He maximizes utility by moving to E
1with 18 hours of leisure (6
hours of work) and a gross pay of £240.
This yields him an after-tax income of £120.
An Income Tax and the Work-leisure Choice

26. An alternative tax: The government raise its £120 through a tax
that did not alter the income-leisure trade-off, say a poll tax.
The after-tax budget line then shifts inward to 21 hours (the tax is
the equivalent of 3 hours work) and £840.
The individual now moves from E
0to E
2.
He consumes 15 hours of leisure (working 9 hours) and £240
worth of goods.
E
2is superior to E
1because it lies on a higher indifference curve.
An Income Tax and the Work-leisure Choice

27. E
0
I
0
I
1
E
1
a
2540
120
16
19
24
0
Income [£]
Dis-incetives of Welfare Schemes

28. The individual is not employed but is receiving benefits of £25 per
day from some income-related scheme.
This puts him at point E
0, consuming 24 hours of leisure and
receiving £25 pounds of income.
He is now offered work at £5 per hour, presenting him with a budget
line that ends at £120 (for 24 hours’ work).
In the absence of the benefit he would locate at E
1.
He would then consume 16 hours of leisure (working 8 hours) and
earning £40 of income.
Dis-incetives of Welfare Schemes

29. But for every £1 he earns he loses £1 of benefit, so the budget line
starts at E
0and is vertical to point a.
At ahe is working 5 hours and still getting £25 but now all from work.
Further work nets him £5 an hour, so the budget line has its normal
slope below a.
Since the indifference curve through E
1, is lower than the curve
through E
0, his rational choice is not to work.
Disincetives of Welfare Schemes

30. MC
2
MC
1
M
B
41.6
£
0
10
Government Failure
Pollution abatement [millions of tonnes]

31. Each tonne of pollution imposes a social cost of £10.
Thus the marginal social benefit of abatement is £10 per tonne as
shown by the M
Bline.
The most efficient method of control is assumed to have a marginal
cost curve of MC
1.
It is now socially optimal to prevent 4 million tonnes of pollution.
Now assume that the government misguidedly chooses an abatement
procedure that has a marginal cost curve of MC
2.
Optimal abatement is now only 1.6 million tonnes.
Government Failure

32. Now assume that the government insists on having 4 million tonnes
abated.
There is now a loss of the light shaded area above marginal benefit
curve and below the MC
2curve.
That loss may exceed the benefit which is given by the dark shaded
area between the b M
Band the MC
2 curves below 1.6 millions tonnes
of abatement.
If so the programme causes a net social loss.
Having no programme would then be better than having the inefficient
one imposed at too high a level of abatement.
Government Failure