c. (5) If the goal of the policy is to provide a greater number of people with a larger quantity of inexpensive Soybean products, will this policy achieve its goal? Why or why not? Weekly Assignment #4-Due Monday (9/19) of Week 5 at the beginning of class Part III. Excise Taxes and Per-Unit Subsidies. Read Schneider, Section 10.3, "Per-Unit Subsidies and Excise Taxes." 4. a. (5) On the graph to the right, show the impact a $20 excise tax on the market for a bottle of Market for Wine wine. This would result in a new equilibrium price 40 of $_ 35 b. (5) The total tax revenue from the $20 excise tax 30 received by the government would be: 25 (show your work) PRI 20 15 D WINE (BOTTLES) c. (5) Producers' total revenue after the excise tax is imposed would be: $_ (show your work) 5. Studies indicate that wine has beneficial health impacts. Suppose that the government decides to eliminate all excise taxes on wine and instead enacts a $10 per bottle subsidy on wine. a. (5) Using the graph of the market for wine above, a $10 per bottle subsidy on wine would result in a new equilibrium price of $_ b. (5) The total cost of the $10 per wine bottle subsidy to the government would be: (show your work) c. (5) Producers' total revenue after the subsidy is established imposed would be (show your work)APPLICATIONS CHISUPPLIAND DEMAND in is found by taking the price of the product and mulusking be the seanut the product sold, Total revenue = TR = Pnce x Quanar sold = P . At point C the total revenue taken in by suppliers is (14 billion . $4 = $5 billion This is substantially more than the $39 billion of total revenue they took in when the equilibrium was at point A. Often the government likes having surplus stores of agricultural crops in case of droughts or famines, or they can use the surplus to supply the military or school lunch programs, However, because storing surplus crops is expensive. sometimes the government actually pays farmers not to produce. For example, in Figure 10.6. the government could have paid farmers not to produce 2 billion bushels of corn Shifting the supply curve to the left by 2 billion would have moved the market equilibrium from point A to point B, and farmers would still be making more money than before. The key takeaways regarding price floors are the following: Price floors are always set above the equilibrium price. Price floors do not shift demand or supply: The higher price causes a movement along both the supply and demand curves. A price floor creates a surplus that results in non-price rationing, the government purchasing the surplus, or the government paying to eliminate the surplus. Another type of government intervention in markets occurs when they use excise taxes or per unit subsidies to discourage or encourage production of particular goods. 10.3 PER UNIT SUBSIDIES AND EXCISE TAXES 10.3.1 Per unit subsidy With a per unit subsidy, the government pays suppliers a fixed amount for each unit they sell. Per unit subsidies increase the supply curve because they lower the costs for suppliers. More specifically, per unit subsidies shift the supply curve down (vertically) by exactly the amount of the per unit subsidy. For example, suppose the federal government decides to help corn farmers with a $1 per bushel subsidy instead of a $4 per bushel price floor (see Figure 10.6). In Figure 10.7, the corn market starts out in equilibrium at point A with a price of $3 and a quantity of 13 billion bushels of corn. A per unit subsidy of $1 per bushel of corn shifts the supply curve down by exactly $1 to S,. Suppliers are now able to sell each bushel of corn for $1 less than before and still make the same amount of money. Notice that point B on the new supply curve S, is exactly $1 below point A on S. But at a price of $2, more corn is demanded than can be supplied, resulting in a shortage and causing the new equilibrium price is rise to $2.30 and the new equilibrium quantity to reach 13.7 billion bushels of corn. The new equilibrium218 MARKETS, SUPPLY AND DEMAND S.-S,-St $3.30 $3.00 $2.30 $2.00 D. 13 13.7 FIGURE 10.7 Effect of a $1 subsidy on the U.S. market for com. can be found at point C on the graph in Figure 10.7, where the new supply cup S, intersects the demand curve . Notice that the equilibrium price tell as a result of the subsidy, but not by $1. Next it is important to determine who benefits from the subsidy and how much this subsidy costs the government. Farmers used to receive $3.00 for car bushel of corn. Now they get $2.30 (the new equilibrium price). plus the $1 sub sidy they receive from the government for each bushel they sell. Thus, farmers pow receive $2.30 + $1.00 = $3.30 per bushel (point D on the graph in Figure 10,7) Which is $0.30 more than they used to get before the subsidy. But why did a subsidy of $1 only make farmers $0.30 more? The rest of the subsidy goes to consumers in the form of lower prices. Consumers used to pay $3.00 per bushel for corn, and now they pay only $2.30. So in this example, consumers receive $0.70 of the $1.00 subsidy (70%), whereas farmers get only $0.30 (30%). After the subsidy, the total revenue of corn producers at point D is $3.30 mul- tiplied by 13.7 billion, which equals $45.21 billion. The cost to the government is the amount of the per unit subsidy multiplied by the new equilibrium quantity. $1x13.7 billion = $13.7 billion. Now let's compare the results of the price floor in Figure 10.6 and the per unit subsidy in Figure 10.7. With the price floor in Figure 10.6, corn farmers take in $56 billion, and it costs the government $8 billion to buy the surplus. Thus, farm- ers make more total revenue at less cost to the government with the price floor. In general, when supply and demand curves are inelastic, as they are with corn, price floors generate only a small surplus for the government to buy, making a price floor less expensive than a per unit subsidy. Of course, consumers always prefer a per unit subsidy to a price floor because a per unit subsidy lowers prices, whereas a price floor raises prices. To recap, per unit subsidies shift the supply curve down by exactly the amount of the subsidy, and that causes the equilibrium price to decrease by some amount less than the subsidy. Part of the subsidy goes to consumers in the form of lowerAPPLICATIONS OF SUPPLY'AND DEMAND prices. and some of the subsidy goes to producers in the form of higher revenues. The opposite of: per unit subsidy is an excise tax. 10.3.2 Excise tax All excise tax is a per unit tax paid by sellers to the government. Excise uses affect the supply curve because they raise costs for suPpliers. in general, when an excise tax is imposed on a good. this causes a decrease in supply. with the supply curve shifting by exactly the amount of the tax. For example. in the graph in Figure 10.8, the initial equilibrium is at point A. with a price of $4 and a quantity of 13 billion packs of cigarettes per year. A $3 excise tax on each pack of cigarettes shifts the supply curve of cigarettes up by exactly 53 (notice that point B is exactly 33 above point A). Producers used to be Willing to supply 13 billion packs at a price of 54. Now that they must pay the gm'crmnent $3 for each pack they sell. producers would like to sell 13 billion packs of cigarettes for $7 per pack to make the same amount of money (point B on the graph]. (Note: We usually say that higher costs shift the supply curve to the left. In the case of an excise tax. it is more useful to shift the supply curve up by exactly the amount of the tax. This allows us to determine more precisely the impact on price and quantity.) Producers will try to pass on some or all of the excise tax to consumers in the form of higher prices. However, cigarette companies can't pass all of the tax on to consumers. At a price of 37 there is a small surplus of cigarettessome consumers stop buying cigarettes at $7 per packwhich forces cigarette producers to lower their prices. The cigarette market nally reaches a new equilibrium at point C in Figure 10.8, at a new equilibrium price of$6.50 and a new equilibrium quantity of 12 billion packs. Cigarette companies were able to raise their prices by $2.50. passing on most ofthe 53 tax to consumers. After the tax. cigarette companies receive $6.50 from 1 3 :11 :i' ""l-I .u 219 220 MARKETS, SUPPLY AND DEMAND consumers. but then they must pay $3 to the government. so cigarette producers receive $6.50 - $3.00 = $3.50 after the tax (point D in Figure 10.8) Th . This is $0.50 nd up paying $0,50 less than they received before the tax, so cigarette sellers end before (point C). of the tax and cigarette buyers pay $2.50 per pack more Meanwhile. the government takes in quite a bit of tax revenue from the cigarette excise tax. The government revenue from an excise tax is tax is found by mul - tiplying the amount of the tax times the new equilibrium q um quantity after the tax. Here, the government takes in $3 per pack multiplied by 12 billion packs for a total of $36 billion. In general, excise taxes shift the supply curve up by exactly the amount of the tax, and this shift causes the equilibrium price to increase by some amount less than the tax. Part of the excise tax is paid by consumers in the form of higher prices, and part of the tax is paid by producers in the form of lower revenues. Another interesting application of the supply and demand model is the notion of consumer and producer surplus. This helps economists evaluate when govern- ment interventions in the marketplace are effective and when they do more harm than good. 10.4 CONSUMER AND PRODUCER SURPLUS AND DEAD WEIGHT LOSS Consumer surplus is the difference between the amount consumers are willing to pay for a good and the price of that good. On a graph, consumer surplus is the area below the demand curve and above the equilibrium price, as seen in Figure 10.9(a). Producer surplus is the difference between the amount for which sellers are willing to sell each unit of a good and the price at which they actually sell the good. On a graph, producer surplus is the area above the supply curve and below the equilibrium price, which is (a) Consumer and producer surplus in the market for sugar P (S/pound) $4 $1 airplus D1 50 Q (billions of pounds of sugar per year) FIGURE 10.9 (a) Consumer and producer surplus in the market for sugar