Macroeconomics Written Assignment 2

Topics: Economics, Free trade, Price index Pages: 5 (1627 words) Published: September 13, 2014
(Written Assignment #2)

Question #1
Market failure according to the author Gregory Mankiw is, “the inability of some unregulated markets to allocate resources efficiently.” (pg 154) “Because buyers and sellers do not consider the side effects when deciding how much to consume and produce, the equilibrium in a market can be inefficient from the standpoint of society as a whole.” (pg 154) This can typically happen through two general phenomenon’s called “market power” and “externalities. Market power is basically when one single person or even a small group of people have the ability to control and influence prices in the market. The example that the text book gave of a farmer who owned the only well in the town and had complete control over the price for the residents in the town to have water which is obviously an essential to life. The other type of market failure has to do with externalities. Externalities are anything that cause the dependence of more than just the value to the buyers and the cost to the sellers. The example in the text book is that of pollution and how the use of agricultural pesticides not only affects the manufacturers but also the farmers who use them, as well as the people who breathe the air and drink the water. Both of these examples aid market failure and are often times overlooked by both the consumer and producers in the market.

Question #2
According to Oliver Wendall Holmes Jr, “taxes are what we pay for a civilized society.” (pg 159) So why then does there always seem to be heated debates regarding taxes? According to the author Mankiw, “a tax raises the price buyers pay and lowers the price sellers receive.” (pg 159) He further goes on to discuss that, “in the end, the elasticities of supply and demand determine how the tax burden is distributed between producers and consumers. This distribution is the same regardless of how it is levied.” (pg 160) Regardless of what is levied it is overall obvious that because of a tax wedge between the seller and the buyer a tax on a good causes the size of the market for that good to shrink. Taxes are a necessary government issuance to provide roads, police and public education or even to help the needy. Therefore according to the author, “we use the government’s tax revenue to measure the public benefit from the tax.” (pg 161) In summary, “a tax of a good reduces the welfare of buyers and sellers of the good, and the reduction in consumer and producer surplus usually exceeds the revenue raised by the government. Often resulting in what is called deadweight loss of the tax.” (pg 172)

Question #3
According to the author deadweight taxes cause, “deadweight losses because they percent buyers and sellers from realizing some of the gains from a trade.” (pg 163) What determines whether the deadweight loss from a tax is large or small? The answer is, “the price elesticities of supply and demand, which measure how much the quantity supplied and quantity demanded respond to changes in the price.” (pg 164) When talking about supply we come to the conclusion that when the supply is inelastic, the deadweight loss of a tax is more small verses when the supply is elastic the deadweight loss of a tax is relatively larger. When talking about the demand of a product we also come to the conclusion that when the demand is inelastic the deadweight loss of a tax is small and when the demand for a product is elastic the deadweight loss of a tax tends to be larger. “A tax has a deadweight loss because it induces buyers and sellers to change their behavior. The tax raises the price paid by buyers, so they consume less. At the same time, the tax lowers the price received by sellers, so they produce less.” (pg 166) Because of this result in changes of behavior, the size of the market shrinks to a less desirable market. We find that the government’s tax revenue is the size of the tax times the amount of the goods sold. “Because a tax reduces the size...
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