Taxes and marginal cost pricing

1
Taxes and marginal cost pricing

• Today Results of taxation Marginal cost
  pricing and efficiency

2
From subsidies to taxes to MC pricing

• Last time, we saw that a subsidy did not work to
  help high rent in Isla Vista
• Today, we talk more generally about a negative
  subsidy, which is called a tax
• After taxes, we will talk about marginal cost
  pricing

3
Taxes

• Governor Arnold Schwarzenegger below

• Three major reasons to charge taxes
• Revenue generation
• The prevention of harming the environment or
  other people (see also Externalities, Ch. 10)
• Limitation of imports (more on this later in
  trade lecture)

4
An example A 1 tax on flashlight suppliers

• Before tax Price is 8.80, and 8 flashlights
  sold

5
An example A 1 tax on flashlight suppliers

• With tax Suppliers must add 1 in additional
  costs for each flashlight sold

6
An example A 1 tax on flashlight suppliers

• With tax
• New equilibrium price paid is 9.20 by consumers
• New equilibrium revenue kept by suppliers, 8.20

7
An example A 1 tax on flashlight suppliers

• Who pays for the tax?
• Consumers pay 0.40 more than before
• Suppliers receive 0.60 less than before

8
What happens with a 1 tax?

• Summary
• Lower quantity sold
• Consumers pay more money per unit sold
• Sellers receive less money per unit sold

9
Deadweight loss

• Deadweight loss is economic surplus that we lose
  by the imposition of a tax
• To determine deadweight loss, we need to find
  surplus and tax revenue generated by tax
• Any potential surplus not realized is deadweight
  loss

10
Surplus and deadweight loss

• Consumer surplus (top ?)
• Producer surplus (bottom ?)
• Tax revenue generated (rectangle)
• Deadweight loss (right ?)

11
More on deadweight loss

• An example related to elasticity
• The smaller the price elasticity of supply, the
  smaller the deadweight loss
• More on deadweight loss in monopoly and
  externality chapters

12
Marginal cost pricing of public services

• Governments often provide (or contract to a
  private firm) some essential services to
  residents

13
Back to MB MC idea

• Remember 1st lecture
• Surplus is typically maximized when MB MC
• Even though services are publicly provided, MB
  MC still applies

14
Example

• Electricity
• 8 Mwh can be provided by coal _at_ 3/Kwh
• 20 Mwh can be provided by natural gas _at_ 5/Kwh
• 10 Mwh can be provided by wind power _at_ 9/Kwh
• 6 Mwh can be provided by solar power _at_ 15/Kwh

15
Example

• 8 Mwh (coal) _at_ 3/Kwh
• 20 Mwh (natural gas) _at_ 5/Kwh
• 10 Mwh (wind power) _at_ 9/Kwh
• 6 Mwh (solar power) _at_ 15/Kwh

• Suppose that at a price of 9/Kwh, 30 Mwh were
  demanded
• All coal capacity and natural gas capacity can be
  used, and 2 Mwh provided by wind
• MC pricing tells us to charge 9 /Kwh in order to
  maximize surplus

16
The invisible hand

• Next time, we will begin to investigate a concept
  called the invisible hand
• Important to know types of profit
• Accounting profit
• Normal profit
• Economic profit
• On next two slides, I introduce some questions
  for you to think about

17
Questions to ponder over the weekend

• Why are TV repair shops harder to find?
• Why has Las Vegas added many expensive hotels on
  its famous strip?

18
Emma the plumber What should she do? (More on
Monday)

• Emma the plumber
• She could either run a home business or work next
  door at AAA Plumbing at 30 per hour
• Either way
• 40 hours / week
• 50 weeks / year

• If she works at home, she assumes that her annual
  revenues and costs will be as follows
• Total revenue 200,000
• Explicit costs 160,000