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ECON 1B03 Lecture Notes - Economic Equilibrium, Tax Incidence, Golden Rule

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Hannah Holmes

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Richard Damra Wednesday, February 13, 2013
Econ 1B03 Chapter 6&8 Supply, Demand & Government Policies
Chapter 6
Quota: is a quantity control. An upper limit on the quantity of the good that can be sold.
Government will usually issue a quota license that give producers to produce a specified aount
of the good. Example: Number of taxis in a city is controlled. Amount of fish you can catch.
Market for Milk:
In an unregulated market, equilibrium P = $1 and Q = 13 million litres per week
The Canadian Dairy Association decides to limit output to increase prices received by producers
and avoid surplus. The neat thing about Quota is that you can’t over produce this no surplus to
worry about.
It makes sure the government backs it up by imposing tariffs on imports of milk from the US.
This will make milk expensive enough so that consumers won’t buy US milk.
The quota is set at 9 million litres per week.
At Q = 9 million, consumers are willing to pay $1.80 per litre (this is the demand price).
But, at that Q, producers would normally, be happy to receive $0.60 per litre
$1.80 = Price consumers pay
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Richard Damra Wednesday, February 13, 2013
$0.60 = Price firms pay
Firms are happy because they receive more money than they would be happy with at the
production of 9 million litres of milk. They receive an extra $1.20 which is considered the quota
rent (value of quota).
Golden rule: Whenever the quantity traded is not equal to equilibrium quantity we are going
to lose total surplus
The difference between these 2 prices is the quota rent: quota owners receive an additional
$1.20 per litre per week.
This is also the value of the quota.
o Someone who wanted to produce milk would be willing to pay up to $1.20 per litre per
week to acquire the rights to produce milk, sell it at $1.80 and net $.60 per litre per
Governments levy taxes to raise revenue for public projects.
Tax incidence: the distribution of a tax burden.
Do buyers or sellers bear the burden when the government imposes a tax?
A tax on Consumers
Example: Market for Beer
P is the price per bottle
Q is the number of bottles sold per week at a very small bar in a farming community
In equilibrium, P = $3.00 and Q = 100
Now suppose the government imposes a tax of $0.50 per bottle on consumers of beer.
Net effect: consumers will demand less beer (law of demand)
The government doesn’t care what the equilibrium price is, and the $0.50 tax will apply no
matter what the price of beer happens to be.
Tax is going to shift the demand curve down and decrease it by the amount of the tax.
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