Economics and Welfare State

Economics and Welfare State

76-118-01

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Thanks to Ayala Klimek

17/02/03

1. Fundamentals of Economics:

a) There is a problem of shortage, and there is demand. Each person has demands, but we are unable to produce all products that people want. People constantly want more and more. In order to produce we need productive factors: (1) manpower; (2) physical resources-building lectures to create more products – selling lectures; (3) raw materials. There are 6 billion people in the world and only a part of them are able to work. This is a limited number. There is also a limitation on the physical resources that we have. There is also a limit to the raw materials we have. Because there are limitations on all 3 levels we are unable to provide all the products that people want and therefore there is a problem of shortage. Usually there is no shortage of air because everyone gets as much as he needs. It is not an economical factor, although in future we do not know what the future holds. All products are economical because there may be a shortage in either of them, besides for air.

b) Due to the problem of shortage people need to decide on their priorities. People face tradeoffs. In economy, as long as there is a decision there is benefit-cost. We need to decide which choice gives us the most benefit. We also need to consider the cost. What is the price we pay (not necessary financial) for the choice we make? E.g. going to the movie we need to pay the price of ticket + the alternative cost (what we could have done instead). Opportunity cost – the cost of something is what you give up to get it.

	A	B
Benefit - תועלת	100	200
Cost - עלות	50	175
Difference - הפרש	50	25

A is a much better choice than B. According to economics we need to consider the difference between the two and to choose the largest difference. Choosing A is a rational choice.

The benefit and the price are subjective and therefore we cannot be judgmental. We just assume that a person makes a rational decision.

2. An Economical Question:

a) What and how much to produce?

We need to decide on the amount of products there will be in the market.

b) How should we produce the product? Should we use all the productive factors or not? Should we use many people or machines?

c) For who should we produce? A company produces DVD but for whom are they producing it? Who will be consuming the products?

3. Systems:

The two types of systems offer difference questions of how to answer these above-mentioned questions. There is a government committee who decides what to produce and how to produce it and how many to produce. The committee also decided for whom to produce the goods.

a) Planning Systems - מערכת תכנון: The government decides on all these factors and answers all 3 questions. This is common to communist governments. There is no private property and the government owns everything. Sometimes, during times of war the state decides what is produces and for whom and how much. Supporters for this system claim that it is more scientific and the committee decides on products that are essential or necessary and not luxuries (e.g. a yoyo is not an essential product). They also claim that there will be equality because a committee decides.

b) Market Systems - מערכת שוק: The market answers all 3 questions. The market is a place in which there is interaction between those who want to sell and those who want to buy. There is an interaction between producers and consumers and this interaction provides the answers. If a seller wants to sell a product and no one wants to buy it then it is not produced. A producer only produces what can be consumer by others.

If a producer decides to produce the product with minimum cost then people will not buy the product. For who should they produce – for consumers who are prepared to pay for the product? This is common in capitalism (i.e. there is private property). Supporters of this system claim that sellers produce what people demand because consumers decide what to buy. There is efficiency in production because there is a personal incentive to work because a person earns. There is competition in the market. The problem with this system is inequality. There is only equal opportunity and not equality between people. The goal is that everyone can is given the potential to succeed. Capitalist countries are more efficient and more productive.

The conflict between the 2 systems:

1) Efficiency vs. Equality (both cannot exist simultaneously).

2) Dynamic vs. Static (market is very dynamic and many changes; the planning market is constant and no thinking of the future).

3) Selfish/egoistic vs. Unselfish (the planning system could not imagine that there could be anything good in egoism).

Adam Smith (1776) claimed that each person gets what he wants and is egotistical. Even under these circumstances there are overall positive results for the market.

Market: A group of buyers and sellers of a particular good or service.

Competitive Market: A market in which there are many buyers and many sellers so that each has a negligible impact on the market price. There are rice takers – sellers and buyers accept price.

Monopoly: Only one seller and he determined the price.

24/02/03

History: Naturally people create markets. An economist during WWII noticed how people created markets (exchange cigarettes for other products).

Adam Smith עושר העמעם: 1776

The “invisible hand” - יד הנעלמה: People are in the market and have there own personal interests. Even if everyone is egoistic this is good for the market. Markets have existed throughout history.

Karl Marx: Communist Manifesto (1848): Published the idea of market systems of communist.

1917: The Revolution and the rise of USSR and the start of communist; a government based on planning systems מערכת השוק.

1929: The Great Depression: There was a decreases in government’s produce and an increase in unemployment. There was 25% unemployment. In German 44% were unemployed. In all developed countries there were problems in markets. In Israel, during the mandate there was no crisis. People thought that this crisis was due to market systems מערכת השוק and therefore there was a need for change.

John Mainhear Haines (1936): Said that sometimes the government must intervene in the market.

WWII: USA was successful because they were able to produce more goods than European countries. This was under the planning system because there was war. This proves that the planning system works. If the government intervenes in the market many goods are produced.

Post WWII: Socialism: The many branches of economy will be under government control, while small branches will be private under market systems. This is the situation in Israel. People said that market system was successful.

1980’s there were changes in USA (Regan) and England (Thatcher).They claimed that there needs to be less government intervention and a return to market systems. These countries were economically successful.

Following WWII Germany was divided: East was planning system; West was market systems.

1989: The Berlin Wall Fell. The standard of living between East and West Germany was compared. The west had higher standard of living than the east. People concluded that the market system was better. Those who lived with planning systems wanted to transfer to market.

USSA fell because the government could not supply produce for everyone. This is an empirical example and proves which method has more advantages.

Globalisation: Supported by those who advocate for market systems.

Conclusion: The market system provides people with a higher standard of living.

There is no 100% market system. The question is to what extent should the government intervene in the market. Why should the government intervene? And how?

The government intervenes because of a number of reasons:

1) Inequality: If the government intervenes then it decreases inequality in the market. Progressive government taxes (each person pays according to his income – the more one earns, the higher his tax in percentages – from 10% to 45%). The government pays unemployment money.

2) Unemployment; recession מיתון: שפל-depression is a more extreme recession. Rines claims that during recession the government should intervene in an emergency program that decreases unemployment.

3) Information: The government provides information. Government intervenes and passes a law that forces sellers to place prices on each product. This gives information to the consumers. Government intervention ensures that each profession will have a degree (e.g. doctor, dentist, lawyer etc). In 100% market system each person can claim he is a doctor and there is no control.

4) Monopoly: When there is only one company in the market it has monopoly. Sometimes even 60% is owned by one company it is considered monopoly. The producers do not have competition and other companies do not allow others companies to enter market. The producer can raise the prices. The government intervenes when a company has monopoly and determined a ceiling price on the product.

5) Public product:

6) Externalities:

How does the government intervene?

1) Control of prices and supervision of quality of goods.

2) Taxes.

3) Subsidies and transfers:

Subsidies: The government gives money either to the producer or consumer. (e.g. buying a house and then mortgaging it). Producers receive subsidies if they produce a good or want to transfer their company.

Transfers: Government collect tax and redistributes among the needy (e.g. Robinhood). Government transfers from rich to poor. The difference between subsidies and transfers is that in subsidies there are conditions while in transfers there are no conditions.

4) Produces goods: They produce money for the market. Israel Bank produces money. The government bank is independent even though it is a government body.

Supply and Demand - ביקוש היצע

Demand: Is there a demand for all types of products (e.g. diamonds are not a necessity). It is a product that is not a necessity but is very expensive, while necessities are cheap). This is Adam Smith’s paradox. However, we must also consider how difficult and expensive it is to produce the product. This idea is problematic. Not everything that is takes time to produce is expensive.

Utilitarianism (Bentine): We need to consider the utility of each product. Utility can be measured on each and every product. Still this is problematic since we cannot compare the utility of diamonds to that of water.

Marginal Utility:

Pizza Utility Marginal Utility

1 5 5

2 9 4

3 11 2

4 12 1

Marginal Utility = ΔTotal U

ΔQuantity

How do we solve the paradox?

Why is water (necessity) cheap and diamond (luxury) expensive?

Marginal utility decreases the more of a product that a person consumes. The marginal utility of the last product decreases. We don’t rush to close the tap because the last litre of water has a low utility. Therefore is very cheap. Diamonds - a person does not need many more than one diamond. The marginal utility of diamonds is therefore very high. What determines the value of products is the marginal utility.

Conclusion: If the marginal utility is high then the product is expensive; if the marginal utility is low then the product is cheap.

3/03/2003 (Missing lesson. Taken form Rachel and added below form book)

10/03/2003 (look at graphs on paper)

DEMAND

Quantity demand: The amount of a good that buyers are willing and able to purchase.

What determines the quantity that people demand?

1) Price:

Law of demand: The claim that, other things equal, the quantity demanded of a good falls when the price of a good rises. Or, as demand increases, price decreases. Indirect correlation between demand and price. The more you buy the cheaper it is. If he buys one unit he pays 8 shekel, if he buys 2 units he pays 6 shekel per unit. That’s a difference of 2 shekel that the consumer gains. If he buys 3 he pays 4 shekel per unit. But for the first product he was prepared to pay 8 shekel. But he as עודף צרכן of 4 shekel.

עודף צרכן: This refers to the difference between what the consumer was prepared to pay minus the what he paid.

2) Income: A lower income means that a person has less money to spare.

Normal good: A good for which, other things held equal, an increase in income leads to an increase in demand (lower income - buy less ice-cream)

Inferior good: A good for which, other things held equal, an increase in income leads to a decrease in demand (lower income, a person sells car – needs more money for bus fare)

3) Change in Prices of related goods:

Substitutes - תחליף: Two goods for which an increase in the price of one leads to an increase in the demand of another (increase in price of ice-cream leads to increase in demand of frozen yogurt; pepsi vs. coke).

Complements - משלים: Two goods for which an increase in the price of one leads to a decrease in the demand for the other (price of chips increases and results in a decrease in demand of tomato sauce).

4) Expectations: Prices will fall in the future, I will but less now.

5) Change in taste:

Demand curve- עקומת הביקוש (D): The graph of a relationship between price of a good and the quantity demanded. How much consumers are prepared to buy. The graph shows a diagonal line from left to right (an indirect/negative correlation).

Market demand vs. Individual Demand:

Market demand: Sum of all individual demands for a particular good or service. Jane and Mark buy a certain quantity of ice-cream for a certain price. The more individuals there are the higher the demand (increase in quantity).

Shifts in the Demand curve - שינויים מעקומת הביקוש

Variables affecting the quantity demanded: price, input prices (wages, rent), technology, bank interest, expectations (if the prices will increase in the future then the producer will only sell the product in the future) and number of sellers. Temperature can change supply- hotter weather more fruit etc. water for agriculture etc.

A change in price represents a movement along the demand curve. A change in any of the other variables shifts the demand curve.

Any change that raises the quantity that consumers want to buy (hot temperature – more ice-cream) shifts the curve to the right/up.

Any change that decreases the quantity that consumers want to buy (ice-cream is bad for cholesterol/ cigarette smoking is a health risk) shifts the curve to the left/down.

Cigarette smoking: A policy to discourage smoking shifts the demand curve to the left/down, while a tax that raises the price of cigarettes results in a movement along the demand curve.

SUPPLY

Supply Curve - עקומת היצע (S) The graph of the relationship between the price of a good and the quantity supplied. How much sellers want to sell a good.

Law of Supply: The claim that, other things equal, the quantity supplied of a good rises when the price of the good rises (direct/positive correlation).

If the price rises (for 5 shekel the producer will sell 10 units; for 8 shekel the produces is prepared to sell 20 units). There is a direct relationship between the price and number of units of the product.

Point A: 10 units for 5 shekel

Point B: 20 units for 8 shekel

Marginal cost: How much it costs the seller to produce the final good. Marginal cost is high to produce the 11^th unit for 5 shekel, because the marginal cost is greater than 5 shekel. He will not get this price in the market and the cost of producing the 11^th unit is too high. However, he is prepared to sell 20 units for 8 shekel, because the marginal cost is not high. The price he gets on the market must be greater than what it costs him to produce it.

When more products are produced the marginal cost increases. Why?

If the marginal cost is constant then the graph line will be horizontal. In this case producing each product cost the same. The producer is prepared to produce an endless number of products.

Shifts in the Supply curve - שינויים מעקומת היצע

Variables affecting the quantity supplied: price, input prices (wages, rent), technology, bank interest, expectations (if the prices will increase in the future then the producer will only sell the product in the future) and number of sellers. Temperature can change supply- hotter weather more fruit etc. water for agriculture etc.

A change in price represents a movement along the supply curve. A change in any of the other variables shifts the supply curve.

Any change that raises the quantity that sellers want to produce (price of sugar decreases in ice-cream industry) shifts the curve to the right/down. Sellers want to sell higher quantity for the same price.

Any change that decreases the quantity that sellers want to produce (price of sugar increases in ice-cream industry) shifts the curve to the left/up. Sellers want to sell less for the same price.

Market Supply - היצע של השוק:

There are 3 producers, A, B, C and we will sketch 3 graphs.

A = 2 units for 3 shekel; 4 units for 5 shekel

B = 0 units for 3 shekel; 1 unit for 5 shekel

C = 5 units for 3 shekel; 7 units for 5 shekel

In all 3 graph as the price rises the number of units rises. This is what is important. There is a direct correlation.

Market = 7 units for 3 shekel; 12 units for 5 shekel

D = 4 units for 3 shekel; 6 units for 5 shekel.

If we add this to the market then we see there is an increase in supply/ היצע.

Conclusion: Therefore an increase in producers leads to an increase in supply.

Supply surplus -עודף היצרן: This refers to the difference between the price the producer receives and what he was prepared to receive for the product (e.g. Producer C = 5 units for 3 shekel; 7 units for 5 shekel; therefore, for the first 5 units he was prepared to receive 3 shekel for each unit. He got 5 shekel for each 7 units (that leaves a difference of 2 for the five first units. 2x5=10). If a person is prepared to sell a house for 100 000 but he is offered 120 000 then he urns an extra 20 000 – this is his עודף יצרן.

Missed lesson – meeting with Margalit………. (31/03/03)

31/03/03 EQUILIBRIUM:

Equilibrium: A situation in which supply and demand have been brought into balance.

Equilibrium Price: A price that balances supply and demand.

Equilibrium Quantity: A quantity supplied and the quantity demanded when the price had adjusted to balance supply and demand.

Surplus: A situation in which quantity supplied is greater than quantity demanded (10 yogurts are supplied and only 4 are demanded). Occurs when the price of the product is above the equilibrium price.

Shortage: A situation in which quantity demanded is greater than quantity supplied (only 4 yogurts are supplied and 10 are demanded). Occurs when the price of the product is below the equilibrium price.

Law of supply and demand: The claim that the price of any good adjusts to bring the supply and demand for that good into balance.

Competitive markets reach equilibrium without intervention.

3 Steps in analyzing changes in equilibrium (pg 83-85)

1) Decide if shift is in supply curve or demand curve.

2) Does the curve shift left or right?

3) Use graph to examine how shift affects equilibrium price and quantity.

Shifts in curves vs. movements along curves:

Supply – refers to the position (left/right) of the supply curve. (Shift in supply curve – change in supply)

Quantity supplied – refers to the amount suppliers wish to sell. (Along the curve – change in quantity supplied)

Sometimes there can be a shift in both supply and demand curves (pg 86)

We can have a large increase in demand and a small decrease in supply (price rises and quantity rises).

We can have a small increase in demand and a large decrease in supply (price rises and quantity falls)

7/4/03 (Exercises on the handout; Graphs)

Chapter 6 : Supply, Demand and Government Policies:

The government intervenes in two ways: Controls on prices and taxes.

Price ceiling: A legal maximum on the price at which a good can be sold. The price can be lower but not higher. Max price occurs when there is a competitive market with many companies that sell a similar product. How does this affect the market?

Look at diagram no. 1. Milk costs 5₪ for 1 liter. If the government declares that the max price is 6 shekel per liter, how will this affect the government. It will not affect the market. If the producers raise the price to 6₪ then fewer people will buy and demand will fall and price will drop to 5₪ again.

But if government declares that max price for milk will be 3₪ then this will affect the market (E, F).

Point E – is supply. There is a decrease form A to E is a decrease in supply. The price decreases – the producers supply fewer products in the market.

Point F – there is an increase in demanded after the price is dropped. The price drops and therefore people want to buy more milk. This is a change in demand.

Is there equilibrium in the market after the binding price ceiling? No, and this creates a shortage because demand is higher than quantity supplied.

Are ceiling prices good? It depends.

For producers: not good because price decreases the amount they are willing to produce and therefore they sell less.

For consumers: it depends. Before hand they sold 10 litres of milk and now they sell 6 milk. There are a few consumers who wanted to buy more milk but there is not enough, so only those who buy benefit. The poor will also not be able to buy because they will not get to the product. Conclusion-it is good only if a consumer buys. When a shortage of a good arises, sellers must ration the scarce goods among the large number of potential buyers.

Other examples are rent control, which also creates a small shortage of housing in the short run and a large shortage in the long run because with time more people flood cites (greater demand) and fewer new houses built (decrease in supply). People respond to incentives.

Independence of Israel (1948). There was a cena (government control over prices). A socialistic approach. The government is involved in the market and determined how much each family received. If there is excess demand a black market rises. The producers sell more products for higher prices to people who want to purchase the products. Therefore price ceilings are not always advantages as is clear from the situation in Israel after independence.

Price Floor: A legal minimum on the price at which a good can be sold.

Equilibrium in the market is at point A (demand curve is equal to supply curve).

The government declares a min price of 3$ The price can be higher but not lower. This is done to help producers. If government declares $3 to be the price floor it is not binding because the equilibrium is $5. But, if the government declares the price floor at $10 it will have impact on market.

Point I = demand quantity. There is a decrease in demand if the min price rises.

Point J = supply quantity. There is an increase of supply because the producers want to sell more. This results in surplus.

Eg. The minimum wage results in Labour surplus/unemployment. The supply increases (more people want to work and sell their services) and the demand decreases (fewer firms want to employ).

Are Price floors good?

For consumers: not good because the price rises and they sell less, so they loose out twice.

For producers: They want to sell J (20 units) but the consumers only want to buy 5 units.

What do they do with the remaining 15 units?

USA solution: The government buys the excess units and the producers don’t suffer, on the contrary, producers gain twice as much (sell at 20 for $10). The government needs to preserve the products, destroy them or to give them to the poor.

Israeli solution: to make a haktsava. Government appraises the quantity of demand and askes the producer to produce that amount and not more. Producers produce less and the price rises per unit.

Is the Israeli solution good for producers? Yes-because price rises but No-because they sell less. What will happen to their pidion = PQ. A min price is declared only if the pidion increases. However this is not good for the consumers. Min price encourages the producers but not the consumers.

28/04/2003

Purchasing Tax – מס קנייה: The tax that the consumer pays when purchasing a product.

But where does the government get the money from? (1) From the producers; (2) From the consumer.

The Tax Incidence refers to the study of who bears the burden of the tax.

Usually the government gets the money from the producer. The money is given to revenue.

The government can also get the tax from the consumer. When one takes a mortgage he needs to get stamps, which prove that he pays purchasing taxes. The government collects this money from the consumer.

Who in the end pays the tax? We check how much the consumer pays before the tax and how much after tax – the difference between them is the amount that the consumer pays.

How much producer gets before tax and how much he has after he transfers the amount to the government. The tax is the difference that the producer pays. Sometimes the producer and consumers each pay part of the tax.

Why does the government have purchasing tax? To make money or to prevent people from buying products (e.g. petrol vs. benzine).

Refer to graph: before tax – the producer gets 5 $ and the consumer buys 10 units

Purchasing tax: 1$ on each product. For each unit the seller sells he has to give $1 to the government. The producer technically transfers the money to the government, but who pays this tax? Look at graph.

After tax the producers need to pay employers, work, electricity, government etc. The producer must collect this money from the consumer. The supply graph moves left/rises (to point B) and he producer wants 6$ per unit because he needs to transfer this shekel to the government.

E.g. 1. But if the producer raises the price to 6$ do the consumers still want to buy 10 units? No, there demand fell to 8 units at 5$. Now we have an excess of supply of 2 units that no one wants to buy. The price therefore needs to decrease. Now a new market equilibrium needs to be reached (9 units for 5.5$ – point E). Conclusion: Consumers buy fewer units when there is tax. Tax affects both consumers and sellers, even though the tax was originally levies on sellers.

Before tax: consumer paid 5$

After tax: consumer pays 5.5 $. The 50 cents is the consumer’s share of the tax paid to the government.

The producer also pays 50 cents tax to the government, because he only earns 4.5$, therefore he loses 50 cents. Both the consumer and producer pay 50% of the tax. The government gets 1$ per product, that’s a total of 9$ for 9 units.

E.g. 2. Petrol: the government has placed taxes on petrol.

No matter what the price the consumer wants to buy 10 units. This is usually what happens with the purchase of medications. Or, petrol – people will buy petrol even if the price increases slightly.

The demand graph is vertical. What happens if there is government imposes a tax of 1$ per unit?

The producer raises the price from 5$ to 6$. The consumer is prepared to pay this price because the demand graph is vertical. Point B is also a point of market balance between supply and demand.

Before tax consumer paid 5$; after tax consumers pay 6$. The consumer therefore pays 100% of the tax, and the producer still gets his 5$ and is therefore not affected by the tax. The government gets 10$ for the 10 units sold.

When supply is more elastic than demand then the burden of tax falls on the customer.

E.g. 3. The demand graph is horizontal. For the price of 5$ the consumer is prepared to buy infinite quantity of products. If the price is 5$ or less then they want to buy infinite number of products. This example is non-realistic. E.g. there are many stands of oranges. If one producer raises the price then no one will buy from him. At point A we have equilibrium. Then the government imposes a tax. The producer wants 6$ for the units (point B). But the max that the consumer is prepared to pay is 5$. Therefore the producer produces 8 units for 5$. The consumer pays 5$ before and after tax therefore he does not pay any tax. The producer got 5$ before tax and 4$ after tax because he transfers 100% (1$ per unit) of the tax to the government. The government gets 8$.

When the demand is more elastic than the supply then the tax falls of the producer.

Conclusion: If the consumer is prepared to pay and price for a product that he wants then he pays the tax. But is the consumer is not prepared to pay any price for a product or he is not really interested in the product then the producer pays most or all of the tax. Sometimes that tax is levied on the seller and sometimes on the buyer, but both buyers and sellers share the burden of taxes. Taxes discourage market activity. When a good is taxed, the quantity of the good sold is smaller in the new equilibrium and the price is higher. Both sides loose.

Subsidies:

When a person/consumer buys a product he gets money from the government. This funding can be given either to the consumer or to the producer.

When does the government give money to the consumer? To new immigrants (loans, mortgages etc. that the government gives).

When does the government subsidize a producer? When a producer builds a company in a certain area (Intel).

Usually subsidies are a waste of money because nothing is left of it.

E.g. 1. Point A is one of equilibrium. For each product that you sell you will get 1$ from the government. The producers cost decreases if he has this subsidy (there is a decrease in production cost).

Point B – for the same price he can sell 12 units.

What about the consumers? The consumers only want to buy 10 units therefore there is an excess of supply of 2 units. Consequently the price drops to 4.5$ (Point C). Equilibrium is restored after a compromise of selling 11 units.

Who enjoys the benefits of the subsidy? Both. The consumer pays less (4.5$) for more product (11). The producer gets 5.5$ (4.5$ + 1$ from government).

So, who looses? The government! The government looses 11$ (for 11 units).

The government gets this money to pay subsidies from taxes.

Is this system beneficial? It depends on how high the taxes are. For the consumer it depends how high a tax a person pays and how much of the product a person buys.

E.g. 2. The demand graph is vertical. Only the consumer gets the benefits of the subsidy.

5/5/2003

Exercise: A kidney costs $150, 000. If people demand that each kidney costs $10,000 then fewer people will take the risk of selling their kidney.

B- decrease in supply and C- decrease in number of kidneys.

When there is excess demand then the price rises.

Who looses? He who knows someone and buys the kidney gains. But (point B)- there will be fewer kidneys on the market. Not every one who even has the money can buy because there are not enough kidneys in the market. These consumer suffer.

The producers loose because he who is prepared to take the change to sell kidney is now prepared to pay for $10,000 instead of $150,000.

The government also looses since they need to pay the dialysis treatment.

1) C) Planning system: Who will loose? Everybody.

All those who need kidneys loose; those who are prepared to sell loose; government looses because they have to finance dialysis.

The only ones who benefit are those who proposed this ethical matter of not selling kidneys.

2) First method: In order to help producers the government decides to raise the price of eggs to a minimum of 7 shekel. This is a change is price and not change in supply or demand.

B – decrease in demand.

C – increase in supply.

In the case of B consumers buy 6 eggs and the government buys the remaining eggs (i.e. 8 eggs).

2) Second method: The producer needs get the same minimum price of 7$ and therefore the government needs to subsidize the producer. There is a subsidy and therefore the producers gets money from government and therefore his costs decrease. The subsidy decreases the market price. E is the new balance in the market after the subsidy. S1 is a decrease in cost of production.

At point E the consumer pays 3$ for 14 eggs and the government pays 4$ to the producer who receives a total of 7$.

Point F – due to the subsidy the producers want to sell more eggs at the price of 5$, but a balance is achieved at point E (14 eggs at 3$).

2) B) There is no different for the producers between the two methods because in both they sell 14 eggs for 7$. (point C and point E).

2) C) The second method is better. Because for the first method the consumers buy 6 eggs for 7 shekel (point B). In the second method the consumers buy 14 eggs for 3$ (point E).

2) D) What is the government cost for both methods.

First method: The government the government must buy 8 eggs for 7$ = Total 56$.

Second method: The government pays 4$ for each egg. 14 eggs were sold so the government paid 4x14 = Total 56$.

Who pays the cost of government? The citizens who pay taxes.

3) A) Government imposes a purchasing taxes of 1$ on each pack of cigarettes.

Both graphs are before the tax. In graph I as the price rises the demand decreases. In graph II when the price rises there in no difference in the demand.

In both graphs there is a growth in cost of production.

In graph I if price in raise to 6 people will not buy and there is excess supply (point C) and therefore a new balance is reached at point B and the price is 5.8$.

In graph II people are prepared to pay any price and therefore the price is raised to 6$.

In graph I: How much tax does consumer pay?

We took at how much he paid before tax: 5$; After tax he pays: 5.8$;

He therefore pays 80% of the tax.

And the producer pays 4.8$ – 20% of the tax.

Both the producer and the consumer loose and the government benefits.

In graph II: The consumer pays 100% of the tax. Before tax he paid 5$ and after tax he paid 6$. The producer does not loose anything. He only transfers the 1$ for the government.

The difference between the answers depends on the demand graph – i.e. how much is a consumer prepared to pay for a product that her demands and the price roses on this product.

If there is change in demand if price rises then both consumer and producer pay the tax. (graph I).

If there is no change in demand when price rises then the consumer pays the full tax. (graph II)

C) Depends on which graph:

In graph I there is change in number of people smoking, while in graph II there is no difference in the number of people smoking.

If the government’s incentive is that people stop smoking then by raising the tax significantly fewer people will smoke and the example will be like graph I.

Summery of examples:

Max price; Min price; Purchasing Tax; Subsidy

In the exam one of these will appear. In these cases the government intervenes in the market. Whenever the government intervenes some loose and some benefit.

For exam know who looses and who gains. Even in subsidy some loose and some gain.

12/05/03

We want to determine the balance in the market. This can be done by means of graphs.

We divide the population into 4 groups (25 in each group).

e.g. 1

Group	Income	Total Income	% Income
Group 1 (n=25)	30,000	750,000	58%
Group 2 (n=.25)	15,000	375,000	29%
Group 3 (n=25)	5,000	125,000	10%
Group 4 (n=25)	2,000	50,000	4%
		1,300,000

We want to find the % of income of each group.

The total income of the population is 1,300,000.

The graph with a direct diagonal line progressing represents equality in income.

The “Laurence” graph shows the state of equality there is in the market. The further it is from the diagonal line the more inequality there is.

e.g.2.

Group	Income	Total Income	% Income
1 (n=25)	40,000	1,000,000	69%
2 (n=25)	10,000	250,000	17%
3 (n=25)	6,000	150,000	11%
4 (n=25)	2,000	50,000	4%
	58,000	1,450,000

The Laurence graph does not chow us in which case there is more equality, because in one point (B vs. E) there is more equality (E) and in another point (C vs. F) there is less equality (F).

Gini Measure:

It gives the area between the line graph and the Laurence graph, which will help us determine the difference in income equality.

Area = (L x H) = (100 x 100) = 5000

2 2

From Example 1:

triangle I trapeze II trapeze III trapeze IV

Area = 25 x 4 + 25 (4+14) + 25 (14+43) + 25 (43+100) = 50+225+712+1776 = 2774

2 2 2 2

5000 – 2774 = 2226

2226 = 0.44 (area between line graph and Laurence graph)

5000

The Genie measure is O.44. A measure only show the change in the measure. The lower the measure the more equality there is. The larger it is the measure the less quality. Therefore if the measure is 1(the highest that it can be) then there is one person who holds all the money and the rest of the population have nothing. The best measure is 0 (i.e. there is no different between Laurence graph and line graph – each % of population has 1% of income).

From Example 2:

triangle I trapeze II trapeze III trapeze IV

Area = 25 x 4 + 25 (4+15) + 25 (15+32) + 25 (32+100) = 50+237+587+1650 = 2524

2 2 2 2

5000 – 2524 = 2476

2476 = 0.49 (area between line graph and Laurence graph)

5000

Now we can compare the two measures. In the first example there is more equality (0.44) and in the second example there is less equality (0.49).

19/05/03

The Poverty Line – קו העוני:

How can one measure the equality or lack of in the market? In inequality there are poor and rich people. With the poverty line we calculate only how may poor people there are. The rest are either rich or middle class.

This person is Poor – what do I mean by this term. His income is below a certain line. This we can determine by knowing what the mean expresses per month are.

Absolute (USA): How much money does a person need to survive - the minimum basis. How much money does he need to fulfill his minimum essential needs? If I determine it to be $1000 then anyone who has below is defined poor. According to this method there is a possibility that there will be no people who are poor because each one will have $1000.

Relative (Israel): They determine relative to other people and not only because he has the basic needs fulfilled. They look at the median income. 50% have higher income and 50% have lower income. Lets say that the median is 5,000ש"ח. The mean will be greater. Poverty is 50% of 5,000 = 2,500 shekel. Each family who has income lower than 2,500 shekel will be considered poor and below poverty line. Any family who earns more than this will be above the poverty line. In the year 2000 the poverty line was 2,677 shekel per family (2 people). Is it possible that there will be no poor people in the state according to the relative method? No, because we always take the median and 50% below it. Even if we are all objectively rich, there will still be those defined a poor because relatively to others some will be poor.

The Tax System – and its affects on equality in the market?

There are 3 types of taxes:

Progressive: Rich people pay higher % of there income to tax.

Neutral: Rich and Poor people pay the same % of income.

Regressive: Poorer people pay higher % of income to taxes.

Poor	Rich	REGRESSIVE TAX
3,000	30,000	Income
2,500	15,000	Expenses before tax
450	2,700	Tax - 18%
450 out of 3,000	2,700 out of 30,000
= 15%	= 9%

Television tax: is regressive because each person pays the same amount.

Neutral tax: In Israel we do not have an example of neutral tax but bituah leumi and health tax is close. For a low salary bituah leumi and heath tax is 2.5 % and if a person has a higher salary then he pays 5%. It is neutral because each person pays the same % of their income to taxes.

Now we want to look at an example of the relation between type of tax and equality in the market.

The Gini measure was 0.44.

Progressive Tax:

10,000 – 10% goes to tax. For anything above this amount a person must pay 50% only on the rest of the sum. On the first 10,000 he pays 10% = 1000 shekel. But if he earns another 20,000 then he pays 50% of this amount, which is 10,000. So he pays a total of 11,000 to income tax. And he earned neto a sum of 19,000. That means 36% of his income he pays to income tax.

	Income	Neto Income	% of income to tax	Total Income	% income
1	30,000	19,000	36%	475,000	52%
2	15,000	11,500	23%	287,500	31%
3	5,000	4500	10%	112,500	12%
4	2,000	1800	10%	45,000	5%
				920,000

We will now calculate Genie measure according to the neto income.

triangle I trapeze II trapeze III trapeze IV

Area = 25 x 5 + 25 (5+17) + 25 (17+48) + 25 (48+100) = 62+275+813+1850 = 3000

2 2 2 2

5000 – 3000 = 2000

2000 = 0.40 (area between line graph and Laurence graph)

5000

The Gini measure is 0.40. The Genie is lower (0.40) than last week (0.44) and therefore there is more equality in the market. When tax is progressive it increase equality in the market.

With Regressive tax:

10,000 = 20%

After 10,000 no % is paid.

	Income	Neto Income	% of income to tax	Total Income	% income
1	30,000	28,000	6%
2	15,000	13,000	13%
3	5,000	4,000	20%
4	2,000	1,600	20%

Gini measure should be 0.48. Is higher than 0.44. There is therefore less equality when there is regressive tax.

Neutral tax neither increases or decreases equality.

In Israel: year 2000:

Genie Measure = 0.509 (before taxes and transferences).

Genie Measure = 0.35 (after taxes and transferences).

If progressive tax says there is inequality in market then government can increase income tax

for anything above the given level. Anything above 10,000 will be taxes 60 or 70 %. The taxes can fall on the rich people. But government will pay a price for making this change.

The efficiency vs equality tradeoff. People will work less if the government will demand high income tax. The incentive to work is decreased and efficiency of market is decreased. There is unemployment money for this who don’t have jobs. These is transferences that increase equality in the market. But does the government pay a price. People who get unemployment money do not search for work and this decreases efficiency in the market. The treasury wants to decrease unemployment money.

Some say that education is a product that increases both equality and efficiency. There is no tradeoff. People will get higher education and their income will increase and equality can be increased. They can work more efficiently and the market will be more efficient.

26/05/03

Exercise from 19/05/03

1) A) Look at page.

B) Gini = 0.33.

C) In Israel 50% of the poverty line is the median. In Israel the poverty line is relative and there will always be poor people (about 20-25%). Because it is 50% of the median. In USA poverty is objective and there can be a situation in which there are no poor people. The poverty line is determined by the minimum income that people need to live to have their basic needs supplied. In Israel if the poverty line decreases then fewer people are poor but they are in the same objective situation. If income increases then the poverty line decreases because fewer people are poor.

e.g. 5 families earn: 6000; 5000; 4000; 3000; 2000.

The median is 4000 because there are two above it and two below it. If I add another income of 7000 then the median will be between 5000 and 4000 (or 4500). It means that 50% of population earn more and 50% of the population earn less.

	Family	Monthly Income	1) 200 shek	2) 25%	3) Tax 50% return 200sh
1	10	500	2000	25% of 500 = 125x10=1250	250 + 200 = net tax =50 10x50=500
2	25	600	5000	25% of 600= 150x25=3750	300 + 200 = net tax=100 25x100=2500
3	10	1000	2000	250x10=2500	500 + 200 = 300 10x300=3000
4	5	2000	1000	500x5=2500	1000 + 200 =800 5x800=4000
			10,000	10,000	10,000

	Family	Monthly Income	200- regressive	25%-neutral	50% + 200 progressive
1	10	500	200/500=40%	125/500=25%	50/500=10%
2	25	600
3	10	1000
4	5	2000	200/2000=10%	800/2000=25%	800/2000=40%

Regressive Tax: There will be less equality.

Neutral Tax: No change in equality.

Progressive Tax: Increases equality in the market.

Marginal tax:

How much of the last shekel must a person pay to taxes. According to the regressive taxing system (200 shekel tax). If I earn more then how much more taxes do I have to pay? Nothing, I only pay 200. The marginal tax is therefore 0.

Neutral tax: The marginal tax will be 25%.

Progressive tax: The marginal tax will be 50%. On each extra shekel he needs to pay 50% to taxes.

Marginal tax is gives a person an incentive to work. If there is marginal tax of 50% then a person have less incentive, but if the marginal tax is lower there is more incentive to work. This connects to equality and efficiency. An increase in equality is usually a decrease in efficiency. Fewer people will want to work and as progressive tax increase then fewer people will work and there will be less given to income tax.

Why does the government intervene in the market. (equality, monopoly etc)

Chapter 10: Externalities

Externality: The uncompensated impact of one person’s actions on the well-being of a bystander.

Positive externality: Has positive benefit on bystander (education, renovation, technology).

Negative externality: Has adverse impact on bystander (pollution, barking dogs)

Negative externalities in production (supply) have social costs. E.g. producing paper has social cost of pollution. We need to calculate the benefits of paper vs. the health risk. The pollution needs to be accounted and less paper need to be produced (shifting the supply curve up/left) to compensate for social cost. At eh new optimum level less paper is produced than at the equilibrium of market quantity level.

How is this change ensured? The government intervenes to decrease production in two ways: regulation by means of passing a law (command and control policies) or taxes (market based policies).

Negative consumption externality (demand). In Alcohol the social value is lower than the demand value and the optimal quantity is lower than the market quantity therefore there are high taxes on alcohol.

2/6/2003

Positive externalities in production have social benefits. Technology benefits the entire society through its spillover affect. Renovation of historic buildings have positive benefit on passers by.

Neighbor example: Want to improve quality of buildings. Cost of one building – S0. but if the company does a number of buildings then total cost decreases to S1.

(e.g. 2 graph 2): Point A of equilibrium. There is benefit to market and to the society. One firm does technological research and has a cost of S0. Another firm can benefit and thus its cost is decreased.

A company wants to develop a new technology and this costs money. To produce the product will be according to S0. Another company wants to develop a similar product. Its cost will be less because they do not need to spent money on research. How many units must the company produce – 10 units. But in the market there need to be 15 and then it will be cheaper for the market. So they want there to be growth in production. If the product has a broad social benefit the, and the social cost (S1) is less that the private cost (S0) then the government can encourage this market and increase quantity form equilibrium level to optimal level by subsidy, thus making cost of firm’s production cheaper (point B).

Positive consumption externality (demand). The social value of education is higher than the demand curve and the optimum quantity is higher than the market quantity therefore education is subsidized by the government.

Private solutions to externalities: The Coase Theorem.

Public Policies towards externalities: regulations, Pigovian Ta, subsidies, pollution permits

Chapter 11: Public Goods and Common Goods

Excludable: Can anyone be prevented from using the product?

Rival: Does one person’s use of a product diminish the other person’s use of it?

Private goods: Rival and Excludable (ice-cream, clothes, congested toll roads).

Natural Monopolies: Non-rival and Excludable (fire protection, Cable TV, un-congested toll roads).

Common resources: Rival and non-Excludable (fishing in sea, environment, congested nontoll roads).

Public goods: Non-Rival and non-Excludable (national defense, knowledge, in-congested nontoll roads, air).

Free rider: a person who receives the benefit of a good but avoids paying for. (e.g. what would occur in the case of a private army to protect the state – no one would pay). In this sort of public good the government usually intervenes.

The tragedy of the commons: A parable that illustrates why common resources get used up more than is desirable form the standpoint of society as a whole. (e.g. public grazing area for cows; fishing in seas).

Why are there still cows? Why is in not result in tragedy. Cows are private property and not a common property so the owner has an incentive to maintain what he has. People can not come and milk or kill cows at their own will.

Exam – 2 sections:

1) Multiple choice.

2) Graphs and calculations.

Balance in market and changes in balances (increase in income, technology: 10-20 points).

Government intervention in market (subsidy, tax, min and max prices: 10-20 points)

Equality or tax: 10-20 points.

What to learn?

Exam till the end of environment awareness.

Not religion.

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Benefit - תועלת

Pizza Utility Marginal Utility

How do we solve the paradox?

3/03/2003 (Missing lesson. Taken form Rachel and added below form book)

What determines the quantity that people demand?

Are Price floors good?

Area = (L x H) = (100 x 100) = 5000

REGRESSIVE TAX

Exercise from 19/05/03