Government Intervention Flashcards
(39 cards)
Redistribution
In order to create economic equality, wealth from the rich is transferred to the poor, usually through tax systems and government spending programs
Equity
Equity amoung people (fairness)
Efficiency
Deadweight loss from government intervention
Equity-Efficiency Tradeoff
The sacrifice of equity for efficiency
Okun’s Bucket
The bucket that leaks money (inefficiency of taking money from the rich and giving it to the poor).
Social Welfare Function
Utility function for society as a whole
Measures how society weights utility of each person’s welfare and uses weights to combine into a function.
Diminishing Marginal Utility of Income
Each additional dollar earned increases marginal utility by a lesser amount than the lost dollar
Marginal Benefit of Redistribution
(Marginal Utility of dollar given to the poor) - (Marginal Utility of dollar taken from the rich) = Marginal benefit
Which of the following is the most important way that the federal government in the United States currently redistributes income?
The progressive taxation system. A progressive taxation system is one in which people with higher income pay a higher percentage of their income in taxes. That means the rich pay more and the poor pay less, so such a system redistributes income. This system is the primary means through which the US federal government redistributes income.
Which of the following programs is most likely to increase income equality in a country?
New job training programs for low-skill workers. Job training programs, especially those for low-skill workers, help those with relatively less income, so they improve income equality.
The government creates a new program that taxes income of billionaires and uses the tax revenue to buy food for low-income citizens. This program will most likely ___________.
Decrease income inequality and decrease efficiency. This program takes money from the wealthiest people and gives these resources to the poor. This will decrease income inequality. However, this program is also likely to decrease efficiency. As we saw in the lecture (with Okun’s leaky bucket analogy), taxing income discourages people from working, leading to some deadweight loss and inefficiency.
The table below shows Karen’s income over two years and the amount of income tax she paid each year.
Suppose there were no changes in the marginal tax-rate schedule. Which of the following is true of Karen’s tax rates?
The average tax rate when Karen earned $64,000 was lower than her marginal tax rate on the last $14,000 she earned that year. In Year 1, Karen’s average income tax was $10,000 / $50,000 = 20%. In Year 2, Karen’s income was higher. Since we know there were no changes in the marginal tax-rate schedule, this allows us to calculate the tax rate on the extra income she earned. She made an extra $14,000 and paid an extra $6,000 in tax. Hence, the marginal tax rate (or the tax rate on this extra money) is $6,000 / $14,000 = 43%. Her average tax in year 2 is $16,000 / $64,000 = 25%. This means that the average tax rate in Year 2 (25%) is lower than the marginal tax rate on the last $14,000 she earned that year (43%).
Suppose County X has a Gini coefficient of 0.5, whereas Country Y has a Gini coefficient of 0.3. Which of the following statements must be true?
Income is more evenly distributed in Country Y. The Gini coefficient is a measure of income inequality. A higher coefficient means more inequality. Hence, since Country Y’s Gini coefficient is lower, it has a more even distribution of income.
Which of the following taxes contributes most to increasing income inequality?
Sales taxes on necessities. A progressive income tax and a proportional income tax both mean that the richest pay more than the poorest, decreasing income inequality. Wealth and property taxes have a similar effect on inequality, since rich people have more wealth and more property. A sales tax on necessities, by contrast, is regressive. The poor spend a larger proportion of their income on necessities like food, so if these are taxed, then the poor pay a higher proportion of their income in sales tax than do the rich. Income inequality will therefore increase.
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Consider a graph for the entire labor market, below. Suppose that the labor market began at equilibrium with supply curve S1 and demand curve D, but that the government imposes a tax on income, represented by the shift to supply curve S2.
With this new tax on income, what happens to employment?
It decreases. At the old equilibrium, employment was E1 and wage was W1. The new equilibrium is where the new supply curve (S2) crosses demand. At that point, employment is E2, which is lower than E1.
Refer to the graph in Question 1A. With the new tax on income, what happens to the income that workers receive?
It decreases. At the old equilibrium, employment was E1 and wage was W1. The new equilibrium is where the new supply curve (S2) crosses demand. At that point, wage is W2. But this is not the wage that the workers receive. Rather, this is wage paid out by the firm, some portion of which goes to the government in taxes. The wage received by the worker is that which corresponds to where the vertical line from the new employment level, E2, intersects the old supply curve, S1. This wage of W3 is lower than the original before-tax wage of W1.
Refer to the graph in Question 1A. What regions represent the workers and firm surplus prior to the tax?
Workers: E + F + G + H; Firm: A + B + C + D. Prior to the tax, the wage is W1 and the supply curve is S1. Worker surplus is the area above the labor supply curve and below the wage line (E + F + G + H). Firm surplus is the area below the labor demand curve and above the wage line (A + B + C + D).
Refer to the graph in Question 1A. What regions represent the workers and firm surplus after the tax?
Workers: H; Firm: A. After the tax, the wage paid by the firm is W2 and the wage received by the workers is W3. The supply curve is S2. Worker surplus is the area above the labor supply curve and below the wage (W3) line (H). Firm surplus is the area below the labor demand curve and above the wage (W2) line (A).
Refer to the graph in Question 1A. What regions represent the government revenue and deadweight loss after the tax?
Government revenue: B + C + E + F; Deadweight loss: D + G. The tax per worker is the difference between the wage the firm pays (W2) and the wage received by the workers (W3). The government gets this revenue for all of the E2 workers who are employed. So the amount of government revenue is (W2 – W3) x E2, or the area of the rectangle B + C + E + F. Deadweight loss is the area of the triangle that used to be a part of the surplus before the tax, between E2 and E1 (triangle D + G). This area represents the lost surplus from labor agreements that would have been made without the tax but are not made with the tax.
Market Failures
Occurs when the free market doesn’t lead to the most efficient welfare maximizing outcome (ex: monopolies)
Negative Externality
In a mutually beneficial trade between two people (A and B), a negative externality occurs when a third party (person C) is negatively affected by the trade, but neither person A or B bear this cost.
Positive Externality
: In a mutually beneficial trade between two people (A and B), a positive externality occurs when a third party (person C) is positively affected by the trade, but neither person A or B get any of this benefit.
Social Marginal Cost
Private Marginal Cost + Externalities Cost
Suppose a nuclear power plant pollutes a river that serves as a water supply for a city. An economist would argue that pollution from the power plant should be reduced until ___________.
The social marginal benefit of clean water is equal to the social marginal cost of clean water. To maximize total social welfare, pollution should be reduced until the social marginal benefit of the clean water is equal to its social marginal cost. If only the private benefits and costs are being considered, the negative externality of the polluted water will lead to a socially inefficient outcome with lower overall social welfare.
