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College of Administrative and Financial Sciences
Assignment-2
Deadline: 06/08/2022 @ 23:59
Course Name: Macroeconomics
Student’s Name:
Course Code: ECON201
Student’s ID Number:
Semester: I
CRN:
Academic Year: 1441/1442 H
For Instructor’s Use only
Instructor’s Name:
Students’ Grade:
/15
Level of Marks: High/Middle/Low
Instructions – PLEASE READ THEM CAREFULLY
•
The Assignment must be submitted on Blackboard (WORD format only) via allocated folder.
•
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•
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poor presentation. This includes filling your information on the cover page.
•
Students must mention question number clearly in their answer.
•
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•
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•
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pictures containing text will be accepted and will be considered plagiarism).
•
Submissions without this cover page will NOT be accepted.
Assignment 2-Case Study-Chapters: 7, 8, 9 & 12
Case Study
When taxes induce people to change their behavior—such as inducing Jane to buy less pizza—the taxes cause
deadweight losses and make the allocation of resources less efficient. As we have already seen, much
government revenue comes from the individual income tax in many countries. In a case study in Chapter 8,
we discussed how this tax discourages people from working as hard as they otherwise might. Another
inefficiency caused by this tax is that it discourages people from saving.
Consider a person 25 years’ old who is considering saving $1,000. If he puts this money in a savings account
that earns 8 percent and leaves it there, he would have $21,720 when he retires at age 65. Yet if the
government taxes one-fourth of his interest income each year, the effective interest rate is only 6 percent.
After 40 years of earning 6 percent, the $1,000 grows to only $10,290, less than half of what it would have
been without taxation. Thus, because interest income is taxed, saving is much less attractive.
Some economists advocate eliminating the current tax system’s disincentive toward saving by changing the
basis of taxation. Rather than taxing the amount of income that people earn, the government could tax the
amount that people spend.
Under this proposal, all income that is saved would not be taxed until the saving is later spent. This alternative
system, called a consumption tax, would not distort people’s saving decisions.
Various provisions of the current tax code already make the tax system a bit like a consumption tax. Taxpayers
can put a limited amount of their saving into special accounts—such as Individual Retirement Accounts and
401(k) plans—that escape taxation until the money is withdrawn at retirement. For people who do most of
their saving through these retirement accounts, their tax bill is, in effect, based on their consumption rather
than their income.
European countries tend to rely more on consumption taxes than does the United States. Most of them raise
a significant amount of government revenue through a value-added tax, or a VAT. A VAT is like the retail sales
tax that many U.S. states use, but rather than collecting all of the tax at the retail level when the consumer
buys the final good, the government collects the tax in stages as the good is being produced (that is, as value
is added by firms along the chain of production). Various U.S. policymakers have proposed that the tax code
move further in direction of taxing consumption rather than income. In 2005, economist Alan Greenspan, then
Chairman of the Federal Reserve, offered this advice to a presidential commission on tax reform: “As you
know, many economists believe that a consumption tax would be best from the perspective of promoting
economic growth—particularly if one were designing a tax system from scratch—because a consumption tax
is likely to encourage saving and capital formation. However, getting from the current tax system to a
consumption tax raises a challenging set of transition issues.”
Q1: What should be taxed – Personal Income or Personal Consumption and why? Provide your opinion
based on the case given above. (Minimum 200 words).
[5 Marks]
Q2: How may it affect Saudi Economy if an income tax is imposed in KSA? (Min 200 words)?
[5 Marks]
Q3: In each of the following cases, determine how much GDP and each of its components is
affected?
[5 Marks]
A. Ahmad spends $300 to buy his dinner at the finest restaurant in Boston.
B. Abdul spends $1500 on a new laptop to use it in his software company in KSA. The laptop
was built in China.
C. Jane spends $1200 on a computer to use in her editing business. She got last year’s model on
sale for a great price from a local manufacturer.
D. General Motors builds $500 million worth of cars, but consumers only buy $470 million
worth of them.
N. Gregory Mankiw
Principles of
Macroeconomics
Sixth Edition
7
Consumers, Producers, and
the Efficiency of Markets
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Premium
PowerPoint
Slides by
Ron Cronovich
In this chapter,
look for the answers to these questions:
• What is consumer surplus? How is it related to
the demand curve?
• What is producer surplus? How is it related to
the supply curve?
• Do markets produce a desirable allocation of
resources? Or could the market outcome be
improved upon?
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Welfare Economics
â–ª Recall, the allocation of resources refers to:
â–ª how much of each good is produced
â–ª which producers produce it
â–ª which consumers consume it
â–ª Welfare economics studies how the allocation
of resources affects economic well-being.
â–ª First, we look at the well-being of consumers.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Willingness to Pay (WTP)
A buyer’s willingness to pay for a good is the
maximum amount the buyer will pay for that good.
WTP measures how much the buyer values the good.
name
WTP
Anthony $250
Chad
175
Flea
300
John
125
Example:
4 buyers’ WTP
for an iPod
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WTP and the Demand Curve
Q: If price of iPod is $200, who will buy an iPod, and
what is quantity demanded?
A: Anthony & Flea will buy an iPod,
Chad & John will not.
name
WTP
Anthony $250
Chad
175
Flea
300
John
125
Hence, Qd = 2
when P = $200.
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WTP and the Demand Curve
Derive the
demand
schedule:
P (price
of iPod)
who buys
Qd
$301 & up nobody
0
251 – 300 Flea
1
Anthony $250
176 – 250 Anthony, Flea
2
Chad
175
3
Flea
300
Chad, Anthony,
126 – 175
Flea
125
John, Chad,
0 – 125
Anthony, Flea
4
name
John
WTP
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WTP and the Demand Curve
P
Q
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
P
Qd
$301 & up
0
251 – 300
1
176 – 250
2
126 – 175
3
0 – 125
4
About the Staircase Shape…
P
This D curve looks like a staircase
with 4 steps – one per buyer.
If there were a huge # of buyers,
as in a competitive market,
there would be a huge #
of very tiny steps,
and it would look
more like a smooth
curve.
Q
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WTP and the Demand Curve
P
Flea’s WTP
Anthony’s WTP
Chad’s WTP
John’s
WTP
Q
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At any Q,
the height of
the D curve is
the WTP of the
marginal buyer,
the buyer who
would leave the
market if P were
any higher.
Consumer Surplus (CS)
Consumer surplus is the amount a buyer is willing
to pay minus the amount the buyer actually pays:
CS = WTP – P
name
WTP
Anthony $250
Suppose P = $260.
Flea’s CS = $300 – 260 = $40.
Chad
175
Flea
300
The others get no CS because
they do not buy an iPod at this
price.
John
125
Total CS = $40.
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CS and the Demand Curve
P
P = $260
Flea’s WTP
Flea’s CS =
$300 – 260 = $40
Total CS = $40
Q
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CS and the Demand Curve
P
Flea’s WTP
Anthony’s WTP
Instead, suppose
P = $220
Flea’s CS =
$300 – 220 = $80
Anthony’s CS =
$250 – 220 = $30
Total CS = $110
Q
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CS and the Demand Curve
P
The lesson:
Total CS equals
the area under
the demand curve
above the price,
from 0 to Q.
Q
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CS with Lots of Buyers & a Smooth D Curve
At Q = 5(thousand),
Price
the marginal buyer
per pair
$
is willing to pay $50
for pair of shoes.
P
The demand for shoes
Suppose P = $30.
Then his consumer
surplus = $20.
1000s of pairs
of shoes
D
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Q
CS with Lots of Buyers & a Smooth D Curve
CS is the area b/w
P and the D curve,
from 0 to Q.
Recall: area of
a triangle equals
½ x base x height
P
The demand for shoes
$
h
Height =
$60 – 30 = $30.
So,
CS = ½ x 15 x $30
= $225.
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D
Q
How a Higher Price Reduces CS
If P rises to $40,
CS = ½ x 10 x $20
= $100.
P
Two reasons for the
fall in CS.
2. Fall in CS due to
remaining buyers
paying higher P
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1. Fall in CS
due to buyers
leaving market
D
Q
ACTIVE LEARNING
1
Consumer surplus
A. Find marginal
buyer’s WTP at
Q = 10.
P
demand curve
$
B. Find CS for
P = $30.
Suppose P falls to $20.
How much will CS
increase due to…
C. buyers entering
the market
D. existing buyers
paying lower price
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Q
ACTIVE LEARNING
Answers
1
A. At Q = 10, marginal
$
buyer’s WTP is $30.
P
demand curve
B. CS = ½ x 10 x $10
= $50
P falls to $20.
C. CS for the
additional buyers
= ½ x 10 x $10 = $50
D. Increase in CS
on initial 10 units
= 10 x $10 = $100
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Q
Cost and the Supply Curve
â–ª Cost is the value of everything a seller must give
up to produce a good (i.e., opportunity cost).
â–ª Includes cost of all resources used to produce
good, including value of the seller’s time.
â–ª Example: Costs of 3 sellers in the lawn-cutting
business.
A seller will produce and sell
name cost
the good/service only if the
Jack
$10
price exceeds his or her cost.
Janet
20
Hence, cost is a measure of
Chrissy
35
willingness to sell.
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Cost and the Supply Curve
Derive the supply schedule
from the cost data:
name
P
Qs
$0 – 9
0
10 – 19
1
20 – 34
2
35 & up
3
cost
Jack
$10
Janet
20
Chrissy
35
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Cost and the Supply Curve
P
Q
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P
Qs
$0 – 9
0
10 – 19
1
20 – 34
2
35 & up
3
Cost and the Supply Curve
P
Chrissy’s
cost
Janet’s
cost
Jack’s cost
Q
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At each Q,
the height of
the S curve
is the cost of the
marginal seller,
the seller who
would leave
the market if
the price were
any lower.
Producer Surplus
PS = P – cost
P
Producer surplus (PS):
the amount a seller
is paid for a good
minus the seller’s cost
Q
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Producer Surplus and the S Curve
PS = P – cost
P
Chrissy’s
cost
Jack’s PS = $15
Janet’s PS = $5
Janet’s
cost
Chrissy’s PS = $0
Total PS = $20
Jack’s cost
Q
Suppose P = $25.
Total PS equals the
area above the supply
curve under the price,
from 0 to Q.
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PS with Lots of Sellers & a Smooth S Curve
Suppose P = $40.
Price
per pair
At Q = 15(thousand),
P
The supply of shoes
the marginal seller’s
cost is $30,
S
and her producer
surplus is $10.
1000s of pairs
of shoes
Q
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PS with Lots of Sellers & a Smooth S Curve
PS is the area b/w
P and the S curve,
from 0 to Q.
P
The supply of shoes
S
The height of this
triangle is
$40 – 15 = $25.
So,
PS = ½ x b x h
= ½ x 25 x $25
= $312.50
h
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Q
How a Lower Price Reduces PS
If P falls to $30,
PS = ½ x 15 x $15
= $112.50
P
1. Fall in PS
due to sellers
leaving market
S
Two reasons for
the fall in PS.
2. Fall in PS due to
remaining sellers
getting lower P
Q
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
ACTIVE LEARNING
2
Producer surplus
A. Find marginal
seller’s cost
at Q = 10.
P
supply curve
B. Find total PS for
P = $20.
Suppose P rises to $30.
Find the increase
in PS due to:
C. selling 5
additional units
D. getting a higher price
on the initial 10 units
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Cengage
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Rights Reserved.
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use. use.
Q
ACTIVE LEARNING
Answers
2
P
supply curve
A. At Q = 10,
marginal cost = $20
B. PS = ½ x 10 x $20
= $100
P rises to $30.
C. PS on
additional units
= ½ x 5 x $10 = $25
D. Increase in PS
on initial 10 units
= 10 x $10 = $100
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Cengage
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except
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Q
CS, PS, and Total Surplus
CS = (value to buyers) – (amount paid by buyers)
= buyers’ gains from participating in the market
PS = (amount received by sellers) – (cost to sellers)
= sellers’ gains from participating in the market
Total surplus = CS + PS
= total gains from trade in a market
= (value to buyers) – (cost to sellers)
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The Market’s Allocation of Resources
â–ª In a market economy, the allocation of resources
is decentralized, determined by the interactions
of many self-interested buyers and sellers.
▪ Is the market’s allocation of resources desirable?
Or would a different allocation of resources make
society better off?
â–ª To answer this, we use total surplus as a measure
of society’s well-being, and we consider whether
the market’s allocation is efficient.
(Policymakers also care about equality, though our
focus here is on efficiency.)
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Efficiency
Total
= (value to buyers) – (cost to sellers)
surplus
An allocation of resources is efficient if it maximizes
total surplus. Efficiency means:
â–ª The goods are consumed by the buyers who
value them most highly.
â–ª The goods are produced by the producers with the
lowest costs.
â–ª Raising or lowering the quantity of a good
would not increase total surplus.
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Evaluating the Market Equilibrium
Market eq’m:
P = $30
Q = 15,000
P
S
Total surplus
= CS + PS
CS
Is the market eq’m
efficient?
PS
D
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Q
Which Buyers Consume the Good?
Every buyer
whose WTP is
≥ $30 will buy.
P
S
Every buyer
whose WTP is
< $30 will not. So, the buyers who value the good most highly are the ones who consume it. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. D Q Which Sellers Produce the Good? Every seller whose cost is ≤ $30 will produce the good. P S Every seller whose cost is > $30 will
not.
So, the sellers with
the lowest cost
produce the good.
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D
Q
Does Eq’m Q Maximize Total Surplus?
At Q = 20,
cost of producing
the marginal unit
is $35
P
S
value to consumers
of the marginal unit
is only $20
Hence, can increase
total surplus
by reducing Q.
This is true at any Q
greater than 15.
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D
Q
Does Eq’m Q Maximize Total Surplus?
At Q = 10,
cost of producing
the marginal unit
is $25
P
S
value to consumers
of the marginal unit
is $40
Hence, can increase
total surplus
by increasing Q.
This is true at any Q
less than 15.
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D
Q
Does Eq’m Q Maximize Total Surplus?
The market
eq’m quantity
maximizes
total surplus:
At any other
quantity,
can increase
total surplus by
moving toward
the market eq’m
quantity.
P
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S
D
Q
Adam Smith and the Invisible Hand
Passages from The Wealth of Nations, 1776
Adam Smith,
1723-1790
―Man has almost constant occasion
for the help of his brethren, and it is
vain for him to expect it from their
benevolence only. He will be more
likely to prevail if he can interest their
self-love in his favor, and show them
that it is for their own advantage to do
for him what he requires of them…
It is not from the benevolence of the
butcher, the brewer, or the baker that
we expect our dinner, but from their
regard to their own interest….
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Adam Smith and the Invisible Hand
Passages from The Wealth of Nations, 1776
Adam Smith,
1723-1790
―Every individual…neither intends to
promote the public interest, nor knows
how much he is promoting it….
He intends only his own gain, and he is
in this, as in many other cases, led by
an invisible hand to promote an end
which was no part of his intention.
Nor is it always the worse for the society
that it was no part of it. By pursuing his
own interest he frequently promotes
that of the society more effectually than
when he really intends to promote it.‖
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The Free Market vs. Govt Intervention
â–ª The market equilibrium is efficient. No other
outcome achieves higher total surplus.
â–ª Govt cannot raise total surplus by changing the
market’s allocation of resources.
▪ Laissez faire (French for ―allow them to do‖):
the notion that govt should not interfere with the
market.
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The Free Market vs. Central Planning
â–ª Suppose resources were allocated not by the
market, but by a central planner who cares about
society’s well-being.
â–ª To allocate resources efficiently and maximize total
surplus, the planner would need to know every
seller’s cost and every buyer’s WTP for every good
in the entire economy.
â–ª This is impossible, and why centrally-planned
economies are never very efficient.
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CONCLUSION
â–ª This chapter used welfare economics to
demonstrate one of the Ten Principles:
Markets are usually a good way to
organize economic activity.
â–ª Important note:
We derived these lessons assuming
perfectly competitive markets.
â–ª In other conditions we will study in later
chapters, the market may fail to allocate
resources efficiently…
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CONCLUSION
â–ª Such market failures occur when:
▪ a buyer or seller has market power—the ability to
affect the market price.
â–ª transactions have side effects, called externalities,
that affect bystanders. (example: pollution)
▪ We’ll use welfare economics to see how public policy
may improve on the market outcome in such cases.
â–ª Despite the possibility of market failure, the analysis
in this chapter applies in many markets, and the
invisible hand remains extremely important.
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SUMMARY
• The height of the D curve reflects the value of the
good to buyers—their willingness to pay for it.
• Consumer surplus is the difference between what
buyers are willing to pay for a good and what they
actually pay.
• On the graph, consumer surplus is the area
between P and the D curve.
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SUMMARY
• The height of the S curve is sellers’ cost of
producing the good. Sellers are willing to sell if
the price they get is at least as high as their cost.
• Producer surplus is the difference between what
sellers receive for a good and their cost of
producing it.
• On the graph, producer surplus is the area
between P and the S curve.
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SUMMARY
• To measure society’s well-being, we use
total surplus, the sum of consumer and producer
surplus.
• Efficiency means that total surplus is maximized,
that the goods are produced by sellers with
lowest cost, and that they are consumed by
buyers who most value them.
• Under perfect competition, the market outcome
is efficient. Altering it would reduce total surplus.
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N. Gregory Mankiw
Principles of
Macroeconomics
Sixth Edition
8
Application:
The Costs of Taxation
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In this chapter,
look for the answers to these questions:
• How does a tax affect consumer surplus,
producer surplus, and total surplus?
• What is the deadweight loss of a tax?
• What factors determine the size of this
deadweight loss?
• How does tax revenue depend on the size of the
tax?
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Review from Chapter 6
â–ª A tax
â–ª drives a wedge between the price buyers pay
and the price sellers receive.
â–ª raises the price buyers pay and lowers the price
sellers receive.
â–ª reduces the quantity bought & sold.
â–ª These effects are the same whether the tax is
imposed on buyers or sellers, so we do not
make this distinction in this chapter.
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The Effects of a Tax
P
Eq’m with no tax:
Price = PE
Quantity = QE
Eq’m with
tax = $T per unit:
Buyers pay PB
Sellers receive PS
Size of tax = $T
S
PB
PE
PS
D
Quantity = QT
QT
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QE
Q
The Effects of a Tax
P
Revenue from tax:
$T x QT
Size of tax = $T
S
PB
PE
PS
D
QT
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QE
Q
The Effects of a Tax
â–ª Next, we apply welfare economics to measure
the gains and losses from a tax.
â–ª We determine consumer surplus (CS),
producer surplus (PS), tax revenue,
and total surplus with and without the tax.
â–ª Tax revenue can fund beneficial services
(e.g., education, roads, police),
so we include it in total surplus.
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The Effects of a Tax
Without a tax,
P
CS = A + B + C
PS = D + E + F
Tax revenue = 0
Total surplus
= CS + PS
=A+B+C
+D+E+F
A
S
B
PE
D
C
E
D
F
QT
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QE
Q
The Effects of a Tax
With the tax,
CS = A
PS = F
Tax revenue
=B+D
Total surplus
=A+B
+D+F
P
A
PB
S
B
D
C
E
PS
D
F
The tax reduces
total surplus by
C+E
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QT
QE
Q
The Effects of a Tax
P
C + E is called the
deadweight loss
(DWL) of the tax,
the fall in total
surplus that
results from a
market distortion,
such as a tax.
A
PB
S
B
D
C
E
PS
D
F
QT
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QE
Q
About the Deadweight Loss
Because of the tax,
the units between
QT and QE are not
sold.
The value of these
units to buyers is
greater than the cost
of producing them,
P
PB
S
PS
D
so the tax prevents
some mutually
beneficial trades.
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QT
QE
Q
ACTIVE LEARNING
1
Analysis of tax
A. Compute
P
The market for
airplane tickets
$
CS, PS, and
total surplus
without a tax.
S
B. If $100 tax
per ticket,
compute
CS, PS,
tax revenue,
total surplus,
and DWL.
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D
Q
ACTIVE LEARNING
1
Answers to A
CS
= ½ x $200 x 100
= $10,000
P
The market for
airplane tickets
$
PS
= ½ x $200 x 100 P =
= $10,000
Total surplus
= $10,000 + $10,000
= $20,000
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S
D
Q
ACTIVE LEARNING
1
Answers to B
CS
= ½ x $150 x 75
= $5,625
P
A $100 tax on
airplane tickets
$
PS = $5,625
PB =
Tax revenue
= $100 x 75
= $7,500
PS =
Total surplus
= $18,750
DWL = $1,250
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S
D
Q
What Determines the Size of the DWL?
â–ª Which goods or services should govt tax
to raise the revenue it needs?
â–ª One answer: those with the smallest DWL.
â–ª When is the DWL small vs. large?
Turns out it depends on the price elasticities
of supply and demand.
â–ª Recall:
The price elasticity of demand (or supply)
measures how much QD (or QS) changes
when P changes.
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DWL and the Elasticity of Supply
When supply
is inelastic,
it’s harder for firms
to leave the market
when the tax
reduces PS.
So, the tax only
reduces Q a little,
P
S
Size
of tax
and DWL is small.
D
Q
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DWL and the Elasticity of Supply
The more elastic is
supply,
the easier for firms
to leave the market
when the tax
reduces PS,
the greater Q falls
below the surplusmaximizing quantity,
P
S
Size
of tax
the greater the DWL.
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D
Q
DWL and the Elasticity of Demand
When demand
is inelastic,
P
S
it’s harder for
consumers to
leave the market
when the tax
raises PB.
Size
of tax
So, the tax only
reduces Q a little,
D
Q
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and DWL is small.
DWL and the Elasticity of Demand
The more elastic is
demand,
P
the easier for buyers
to leave the market
when the tax
increases PB,
S
Size
of tax
the more Q falls
below the surplusmaximizing quantity,
D
Q
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and the greater the
DWL.
ACTIVE LEARNING
2
Elasticity and the DWL of a tax
Would the DWL of a tax be larger if the
tax were on:
A. Breakfast cereal or sunscreen?
B. Hotel rooms in the short run or
hotel rooms in the long run?
C. Groceries or meals at fancy restaurants?
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ACTIVE LEARNING
Answers
2
A. Breakfast cereal or sunscreen
From Chapter 5:
Breakfast cereal has more close substitutes
than sunscreen, so demand for breakfast cereal
is more price-elastic than demand for
sunscreen.
So, a tax on breakfast cereal would cause a
larger DWL than a tax on sunscreen.
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ACTIVE LEARNING
Answers
2
B. Hotel rooms in the short run or long run
From Chapter 5:
The price elasticities of demand and supply
for hotel rooms are larger in the long run than
in the short run.
So, a tax on hotel rooms would cause a larger
DWL in the long run than in the short run.
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ACTIVE LEARNING
Answers
2
C. Groceries or meals at fancy restaurants
From Chapter 5:
Groceries are more of a necessity and therefore
less price-elastic than meals at
fancy restaurants.
So, a tax on restaurant meals would cause a
larger DWL than a tax on groceries.
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ACTIVE LEARNING
3
Discussion question
â–ª The government must raise tax revenue to pay
for schools, police, etc. To do this, it can either
tax groceries or meals at fancy restaurants.
â–ª Which should it tax?
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How Big Should the Government Be?
â–ª A bigger government provides more services,
but requires higher taxes, which cause DWLs.
â–ª The larger the DWL from taxation,
the greater the argument for smaller government.
â–ª The tax on labor income is especially important;
it’s the biggest source of govt revenue.
â–ª For the typical worker, the marginal tax rate
(the tax on the last dollar of earnings) is about 40%.
â–ª How big is the DWL from this tax?
It depends on elasticity….
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How Big Should the Government Be?
â–ª If labor supply is inelastic, then this DWL is
small.
â–ª Some economists believe labor supply is
inelastic, arguing that most workers work
full-time regardless of the wage.
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How Big Should the Government Be?
Other economists believe labor taxes are highly
distorting because some groups of workers have
elastic supply and can respond to incentives:
â–ª Many workers can adjust their hours,
e.g., by working overtime.
â–ª Many families have a 2nd earner with discretion
over whether and how much to work.
â–ª Many elderly choose when to retire based on the
wage they earn.
▪ Some people work in the “underground economy”
to evade high taxes.
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The Effects of Changing the Size of the Tax
â–ª Policymakers often change taxes, raising some
and lowering others.
â–ª What happens to DWL and tax revenue when
taxes change? We explore this next….
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DWL and the Size of the Tax
Initially, the tax is
T per unit.
Doubling the tax
causes the DWL
to more than
double.
P
new
DWL
S
2T
T
D
initial
DWL
Q2
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Q1
Q
DWL and the Size of the Tax
Initially, the tax is
T per unit.
Tripling the tax
causes the DWL
to more than
triple.
P
new
DWL
S
T
3T
D
initial
DWL
Q3
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Q1
Q
DWL and the Size of the Tax
Implication
When tax rates are
low, raising them
doesn’t cause much
harm, and lowering
them doesn’t bring
much benefit.
When tax rates are
high, raising them is
very harmful, and
cutting them is very
beneficial.
Summary
When a tax increases,
DWL rises even more.
DWL
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Tax size
Revenue and the Size of the Tax
When the
tax is small,
increasing it
causes tax
revenue to rise.
P
PB
S
PB
2T
PS
T
D
PS
Q2
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Q1
Q
Revenue and the Size of the Tax
P
PB
PB
When the
tax is larger,
increasing it
causes tax
revenue to fall.
S
3T
2T
D
PS
PS
Q3
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Q2
Q
Revenue and the Size of the Tax
The Laffer curve
Tax
shows the
revenue
relationship
between
the size of the tax
and tax revenue.
The Laffer curve
Tax size
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SUMMARY
• A tax on a good reduces the welfare of buyers
and sellers. This welfare loss usually exceeds
the revenue the tax raises for the govt.
• The fall in total surplus (consumer surplus,
producer surplus, and tax revenue) is called the
deadweight loss (DWL) of the tax.
• A tax has a DWL because it causes consumers
to buy less and producers to sell less, thus
shrinking the market below the level that
maximizes total surplus.
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SUMMARY
• The price elasticities of demand and supply
measure how much buyers and sellers respond
to price changes. Therefore, higher elasticities
imply higher DWLs.
• An increase in the size of a tax causes the DWL
to rise even more.
• An increase in the size of a tax causes revenue
to rise at first, but eventually revenue falls
because the tax reduces the size of the market.
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N. Gregory Mankiw
Principles of
Macroeconomics
Sixth Edition
9
Application:
International Trade
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Premium
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In this chapter,
look for the answers to these questions:
• What determines how much of a good a country
will import or export?
• Who benefits from trade? Who does trade
harm? Do the gains outweigh the losses?
• If policymakers restrict imports, who benefits?
Who is harmed? Do the gains from restricting
imports outweigh the losses?
• What are some common arguments for
restricting trade? Do they have merit?
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Introduction
â–ª Recall from Chapter 3:
A country has a comparative advantage in a
good if it produces the good at lower opportunity
cost than other countries.
Countries can gain from trade if each exports the
goods in which it has a comparative advantage.
â–ª Now we apply the tools of welfare economics
to see where these gains come from and
who gets them.
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The World Price and
Comparative Advantage
â–ª PW = the world price of a good,
the price that prevails in world markets
â–ª PD = domestic price without trade
â–ª If PD < PW, â–ª country has comparative advantage in the good â–ª under free trade, country exports the good â–ª If PD > PW,
â–ª country does not have comparative advantage
â–ª under free trade, country imports the good
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The Small Economy Assumption
â–ª A small economy is a price taker in world markets:
Its actions have no effect on PW.
▪ Not always true—especially for the U.S.—but
simplifies the analysis without changing its lessons.
â–ª When a small economy engages in free trade,
PW is the only relevant price:
â–ª No seller would accept less than PW, since
she could sell the good for PW in world markets.
â–ª No buyer would pay more than PW, since
he could buy the good for PW in world markets.
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A Country That Exports Soybeans
Without trade,
PD = $4
Q = 500
PW = $6
Under free trade,
â–ª domestic
consumers
demand 300
â–ª domestic producers
supply 750
â–ª exports = 450
P
Soybeans
S
exports
$6
$4
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D
300 500 750
Q
A Country That Exports Soybeans
Without trade,
CS = A + B
PS = C
Total surplus
=A+B+C
With trade,
CS = A
PS = B + C + D
Total surplus
=A+B+C+D
Soybeans
P
S
exports
A
$6
B
$4
C
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D
gains
from trade
D
Q
ACTIVE LEARNING
1
Analysis of trade
Without trade,
PD = $3000, Q = 400
P
Plasma TVs
S
In world markets,
PW = $1500
Under free trade,
how many TVs
will the country
import or export?
$3000
$1500
Identify CS, PS, and
total surplus without
trade, and with trade.
D
200
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400
600
Q
ACTIVE LEARNING
Answers
1
Under free trade,
â–ª domestic
consumers
demand 600
â–ª domestic
producers
supply 200
â–ª imports = 400
P
Plasma TVs
S
$3000
$1500
D
imports
200
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600
Q
ACTIVE LEARNING
Answers
Without trade,
CS = A
PS = B + C
Total surplus
=A+B+C
1
P
Plasma TVs
S
gains
from trade
A
$3000
With trade,
B
CS = A + B + D
$1500
C
PS = C
Total surplus
=A+B+C+D
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D
imports
D
Q
Summary: The Welfare Effects of Trade
PD < PW PD > PW
direction of trade
exports
imports
consumer surplus
falls
rises
producer surplus
rises
falls
total surplus
rises
rises
Whether a good is imported or exported,
trade creates winners and losers.
But the gains exceed the losses.
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Other Benefits of International Trade
â–ª Consumers enjoy increased variety of goods.
â–ª Producers sell to a larger market, may achieve
lower costs by producing on a larger scale.
â–ª Competition from abroad may reduce market
power of domestic firms, which would increase
total welfare.
â–ª Trade enhances the flow of ideas, facilitates the
spread of technology around the world.
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Then Why All the Opposition to Trade?
â–ª Recall one of the Ten Principles from Chapter 1:
Trade can make everyone better off.
â–ª The winners from trade could compensate the losers
and still be better off.
â–ª Yet, such compensation rarely occurs.
â–ª The losses are often highly concentrated among
a small group of people, who feel them acutely.
The gains are often spread thinly over many people,
who may not see how trade benefits them.
â–ª Hence, the losers have more incentive to organize
and lobby for restrictions on trade.
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Tariff: An Example of a Trade Restriction
â–ª Tariff: a tax on imports
â–ª Example: Cotton shirts
PW = $20
Tariff: T = $10/shirt
Consumers must pay $30 for an imported shirt.
So, domestic producers can charge $30 per shirt.
â–ª In general, the price facing domestic buyers &
sellers equals (PW + T ).
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Analysis of a Tariff on Cotton Shirts
P
PW = $20
Cotton shirts
Free trade:
buyers demand 80
sellers supply 25
imports = 55
S
T = $10/shirt
price rises to $30
buyers demand 70
sellers supply 40
imports = 30
$30
$20
imports
imports
25
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40
70 80
D
Q
Analysis of a Tariff on Cotton Shirts
Free trade
CS = A + B + C
+D+E+F
PS = G
Total surplus = A + B
+C+D+E+F+G
P
Cotton
shirts
deadweight
loss = D + F
S
A
Tariff
CS = A + B
$30
C
D
PS = C + G
$20
G
Revenue = E
Total surplus = A + B
25 40
+C+E+G
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B
E
F
70 80
D
Q
Analysis of a Tariff on Cotton Shirts
P
D = deadweight loss
from the
overproduction
of shirts
F = deadweight loss
from the underconsumption
of shirts
Cotton
shirts
deadweight
loss = D + F
S
A
B
$30
$20
C
D
E
F
G
25
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40
70 80
D
Q
Import Quotas:
Another Way to Restrict Trade
â–ª An import quota is a quantitative limit on imports
of a good.
â–ª Mostly has the same effects as a tariff:
â–ª Raises price, reduces quantity of imports.
▪ Reduces buyers’ welfare.
▪ Increases sellers’ welfare.
â–ª A tariff creates revenue for the govt. A quota
creates profits for the foreign producers of the
imported goods, who can sell them at higher price.
â–ª Or, govt could auction licenses to import to
capture this profit as revenue. Usually it does not.
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Arguments for Restricting Trade
1. The jobs argument
Trade destroys jobs in industries that compete
with imports.
Economists’ response:
Look at the data to see whether rising imports
cause rising unemployment…
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U.S. Imports & Unemployment,
Decade averages, 1961–2010
Imports
(% of GDP)
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20012010
19912000
19811990
19711980
19611970
Unemployment
(% of labor force)
Arguments for Restricting Trade
1. The jobs argument
Trade destroys jobs in the industries that compete
against imports.
Economists’ response:
Total unemployment does not rise as imports rise,
because job losses from imports are offset by
job gains in export industries.
Even if all goods could be produced more cheaply
abroad, the country need only have a
comparative advantage to have a viable export
industry and to gain from trade.
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Arguments for Restricting Trade
2. The national security argument
An industry vital to national security should be
protected from foreign competition, to prevent
dependence on imports that could be disrupted
during wartime.
Economists’ response:
Fine, as long as we base policy on true security
needs.
But producers may exaggerate their own
importance to national security to obtain
protection from foreign competition.
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Arguments for Restricting Trade
3. The infant-industry argument
A new industry argues for temporary protection
until it is mature and can compete with foreign
firms.
Economists’ response:
Difficult for govt to determine which industries
will eventually be able to compete and whether
benefits of establishing these industries exceed
cost to consumers of restricting imports.
Besides, if a firm will be profitable in the long run,
it should be willing to incur temporary losses.
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Arguments for Restricting Trade
4. The unfair-competition argument
Producers argue their competitors in another
country have an unfair advantage,
e.g. due to govt subsidies.
Economists’ response:
Great! Then we can import extra-cheap products
subsidized by the other country’s taxpayers.
The gains to our consumers will exceed the
losses to our producers.
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Arguments for Restricting Trade
5. The protection-as-bargaining-chip argument
Example: The U.S. can threaten to limit imports
of French wine unless France lifts their quotas
on American beef.
Economists’ response:
Suppose France refuses. Then the U.S. must
choose between two bad options:
A) Restrict imports from France, which reduces
welfare in the U.S.
B) Don’t restrict imports, which reduces U.S.
credibility.
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Trade Agreements
â–ª A country can liberalize trade with
â–ª unilateral reductions in trade restrictions
â–ª multilateral agreements with other nations
â–ª Examples of trade agreements:
â–ª North American Free Trade Agreement
(NAFTA), 1993
â–ª General Agreement on Tariffs and Trade
(GATT), ongoing
â–ª World Trade Organization (WTO), est. 1995,
enforces trade agreements, resolves disputes
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SUMMARY
• A country will export a good if the world price of the
good is higher than the domestic price without trade.
Trade raises producer surplus, reduces consumer
surplus, and raises total surplus.
• A country will import a good if the world price
is lower than the domestic price without trade.
Trade lowers producer surplus but raises consumer
and total surplus.
• A tariff benefits producers and generates revenue
for the govt, but the losses to consumers exceed
these gains.
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SUMMARY
• Common arguments for restricting trade include:
protecting jobs, defending national security,
helping infant industries, preventing unfair
competition, and responding to foreign trade
restrictions.
• Some of these arguments have merit in some
cases, but economists believe free trade is
usually the better policy.
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A Country That Imports Plasma TVs
Without trade,
PD = $3000
Q = 400
P
Plasma TVs
S
PW = $1500
Under free trade,
$3000
â–ª domestic
consumers
$1500
demand 600
â–ª domestic producers
supply 200
â–ª imports = 400
D
imports
200
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400
600
Q
A Country That Imports Plasma TVs
Without trade,
CS = A
PS = B + C
Total surplus
=A+B+C
P
Plasma TVs
S
gains
from trade
A
$3000
With trade,
B
CS = A + B + D
$1500
C
PS = C
Total surplus
=A+B+C+D
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D
imports
D
Q
In the News: Textile Imports from China
On 12/31/2004,
U.S. quotas on
apparel & textile
products expired.
During Jan 2005:
â–ª U.S.
these
The
U.S.imports
textile of
industry
products
from
China
& labor
unions
fought
for
over 70%. November 2005:
newincreased
trade restrictions.
Bush administration agreed
â–ª Loss
of 12,000
The
National
Retailjobs
in U.S. textile
industry.
Federation
opposed
any to limit growth in imports
from China.
restrictions.
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N. Gregory Mankiw
Principles of
Macroeconomics
Sixth Edition
12
Production and Growth
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Premium
PowerPoint
Slides by
Ron Cronovich
In this chapter,
look for the answers to these questions:
• What are the facts about living standards and
growth rates around the world?
• Why does productivity matter for living
standards?
• What determines productivity and its growth
rate?
• How can public policy affect growth and living
standards?
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A typical family with all their possessions in
the U.K., an advanced economy
GDP per capita:
Life expectancy:
Adult literacy:
$36,130
80 years
99%
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A typical family with all their possessions in
Mexico, a middle income country
GDP per capita:
Life expectancy:
Adult literacy:
$14,270
76 years
86%
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A typical family with all their possessions in
Mali, a poor country
GDP per capita:
Life expectancy:
Adult literacy:
$1,090
52 years
46%
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Incomes
and Growth
Around the
World
FACT 1:
There are
vast
differences
in living
standards
around the
world.
GDP per
Growth rate,
capita, 2009 1970–2009
China
Singapore
India
Japan
Spain
Israel
Colombia
United States
Canada
Philippines
Rwanda
New Zealand
Argentina
Saudi Arabia
Chad
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
$6,828
$50,633
$3,296
$32,418
$32,150
$27,656
$8,959
$45,989
$37,808
$3,542
$1,136
$28,993
$14,538
$23,480
$1,300
7.4%
4.7%
3.3%
2.2%
2.1%
2.1%
1.9%
1.8%
1.7%
1.3%
1.1%
1.1%
1.0%
0.6%
0.4%
Incomes
and Growth
Around the
World
FACT 2:
There is
also great
variation
in growth
rates across
countries.
GDP per
Growth rate,
capita, 2009 1970–2009
China
Singapore
India
Japan
Spain
Israel
Colombia
United States
Canada
Philippines
Rwanda
New Zealand
Argentina
Saudi Arabia
Chad
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
$6,828
$50,633
$3,296
$32,418
$32,150
$27,656
$8,959
$45,989
$37,808
$3,542
$1,136
$28,993
$14,538
$23,480
$1,300
7.4%
4.7%
3.3%
2.2%
2.1%
2.1%
1.9%
1.8%
1.7%
1.3%
1.1%
1.1%
1.0%
0.6%
0.4%
Incomes and Growth Around the World
Since growth rates vary, the country rankings can
change over time:
â–ª Poor countries are not necessarily doomed to
poverty forever, e.g. Singapore incomes were
low in 1960 and are quite high now.
▪ Rich countries can’t take their status for
granted: They may be overtaken by poorer but
faster-growing countries.
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Incomes and Growth Around the World
Questions:
â–ª Why are some countries richer than others?
â–ª Why do some countries grow quickly while
others seem stuck in a poverty trap?
â–ª What policies may help raise growth rates and
long-run living standards?
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Productivity
â–ª Recall one of the Ten Principles from Chap. 1:
A country’s standard of living depends
on its ability to produce g&s.
â–ª This ability depends on productivity,
the average quantity of g&s produced
per unit of labor input.
â–ª Y = real GDP = quantity of output produced
L = quantity of labor
so productivity = Y/L (output per worker)
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Why Productivity Is So Important
▪ When a nation’s workers are very productive,
real GDP is large and incomes are high.
â–ª When productivity grows rapidly, so do living
standards.
â–ª What, then, determines productivity and its
growth rate?
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Physical Capital Per Worker
â–ª Recall: The stock of equipment and structures
used to produce g&s is called [physical] capital,
denoted K.
â–ª K/L = capital per worker.
â–ª Productivity is higher when the average worker
has more capital (machines, equipment, etc.).
â–ª i.e.,
an increase in K/L causes an increase in Y/L.
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Human Capital Per Worker
â–ª Human capital (H):
the knowledge and skills workers acquire
through education, training, and experience
▪ H/L = the average worker’s human capital
â–ª Productivity is higher when the average worker
has more human capital (education, skills, etc.).
â–ª i.e.,
an increase in H/L causes an increase in Y/L.
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Natural Resources Per Worker
â–ª Natural resources (N): the inputs into production
that nature provides, e.g., land, mineral deposits
â–ª Other things equal,
more N allows a country to produce more Y.
In per-worker terms,
an increase in N/L causes an increase in Y/L.
â–ª Some countries are rich because they have
abundant natural resources
(e.g., Saudi Arabia has lots of oil).
â–ª But countries need not have much N to be rich
(e.g., Japan imports the N it needs).
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Technological Knowledge
▪ Technological knowledge: society’s
understanding of the best ways to produce g&s
â–ª Technological progress does not only mean
a faster computer, a higher-definition TV,
or a smaller cell phone.
â–ª It means any advance in knowledge that boosts
productivity (allows society to get more output
from its resources).
â–ª e.g., Henry Ford and the assembly line.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Tech. Knowledge vs. Human Capital
▪ Technological knowledge refers to society’s
understanding of how to produce g&s.
â–ª Human capital results from the effort people
expend to acquire this knowledge.
â–ª Both are important for productivity.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Production Function
â–ª The production function is a graph or equation
showing the relation between output and inputs:
Y = A F(L, K, H, N)
F( ) is a function that shows how inputs are
combined to produce output
―A‖ is the level of technology
▪ ―A‖ multiplies the function F( ),
so improvements in technology (increases in ―A‖)
allow more output (Y) to be produced from any
given combination of inputs.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
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The Production Function
Y = A F(L, K, H, N)
â–ª The production function has the property
constant returns to scale: Changing all inputs
by the same percentage causes output to change
by that percentage. For example,
â–ª Doubling all inputs (multiplying each by 2)
causes output to double:
2Y = A F(2L, 2K, 2H, 2N)
â–ª Increasing all inputs 10% (multiplying each by 1.1)
causes output to increase by 10%:
1.1Y = A F(1.1L, 1.1K, 1.1H, 1.1N)
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The Production Function
Y = A F(L, K, H, N)
â–ª If we multiply each input by 1/L, then
output is multiplied by 1/L:
Y/L = A F(1, K/L, H/L, N/L)
â–ª This equation shows that productivity
(output per worker) depends on:
â–ª the level of technology (A)
â–ª physical capital per worker
â–ª human capital per worker
â–ª natural resources per worker
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ACTIVE LEARNING
1
Discussion Question
Which of the following policies do you think would
be most effective at boosting growth and living
standards in a poor country over the long run?
a. Offer tax incentives for investment by local firms
b. ‖
‖
‖
‖
‖
by foreign firms
c. Give cash payments for good school attendance
d. Crack down on govt corruption
e. Restrict imports to protect domestic industries
f. Allow free trade
g. Give away condoms
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Cengage
2012 Cengage
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Learning.
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Rights Reserved.
May notMay
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except
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with a product
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ECONOMIC GROWTH
AND PUBLIC POLICY
Next, we look at the ways
public policy can affect
long-run growth in productivity
and living standards.
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Saving and Investment
â–ª We can boost productivity by increasing K,
which requires investment.
â–ª Since resources scarce, producing more capital
requires producing fewer consumption goods.
â–ª Reducing consumption = increasing saving.
This extra saving funds the production of
investment goods.
(More details in the next chapter.)
â–ª Hence, a tradeoff between current and future
consumption.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Diminishing Returns and the Catch-Up
Effect
â–ª The govt can implement policies that raise
saving and investment. (Details in next chapter.)
Then K will rise, causing productivity and living
standards to rise.
â–ª But this faster growth is temporary,
due to diminishing returns to capital:
As K rises, the extra output from an additional
unit of K falls….
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The Production Function & Diminishing Returns
If workers
Output per
have little
K,
worker
giving
them more
(productivity)
increases their
productivity a lot.
Y/L
If workers already
have a lot of K,
giving them more
increases
productivity
fairly little.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
K/L
Capital per worker
The catch-up effect: the property whereby poor
countries tend to grow more rapidly than rich ones
Y/L
Rich country’s
growth
Poor country’s
growth
K/L
Poor country
starts here
Rich country starts here
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Example of the Catch-Up Effect
▪ Over 1960–1990, the U.S. and S. Korea devoted
a similar share of GDP to investment, so you
might expect they would have similar growth
performance.
â–ª But growth was >6% in Korea and only 2% in
the U.S.
â–ª Explanation: the catch-up effect.
In 1960, K/L was far smaller in Korea than
in the U.S., hence Korea grew faster.
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Investment from Abroad
â–ª To raise K/L and hence productivity, wages, and
living standards, the govt can also encourage
â–ª foreign direct investment:
a capital investment (e.g., a factory) that is
owned & operated by a foreign entity
â–ª foreign portfolio investment:
a capital investment financed with foreign
money but operated by domestic residents
â–ª Some of the returns from these investments
flow back to the foreign countries that supplied
the funds.
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Investment from Abroad
â–ª Especially beneficial in poor countries that cannot
generate enough saving to fund investment
projects themselves.
â–ª Also helps poor countries learn state-of-the-art
technologies developed in other countries.
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Education
â–ª Govt can increase productivity by promoting
education–investment in human capital (H).
â–ª Public schools, subsidized loans for college
â–ª Education has significant effects: In the U.S.,
each year of schooling raises a worker’s wage
by 10%.
â–ª But investing in H also involves a tradeoff
between the present & future:
Spending a year in school requires sacrificing
a year’s wages now to have higher wages later.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Health and Nutrition
â–ª
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Property Rights and Political Stability
â–ª Recall:
Markets are usually a good
way to organize economic activity.
The price system allocates resources
to their most efficient uses.
â–ª This requires respect for property rights, the
ability of people to exercise authority over the
resources they own.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Property Rights and Political Stability
â–ª In many poor countries, the justice system
doesn’t work very well:
▪ Contracts aren’t always enforced
â–ª Fraud, corruption often go unpunished
â–ª In some, firms must bribe govt officials for
permits
â–ª Political instability (e.g., frequent coups) creates
uncertainty over whether property rights will be
protected in the future.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Property Rights and Political Stability
â–ª When people fear their capital may be stolen by
criminals or confiscated by a corrupt govt,
there is less investment, including from abroad,
and the economy functions less efficiently.
Result: lower living standards.
â–ª Economic stability, efficiency, and healthy
growth require law enforcement, effective courts,
a stable constitution, and honest govt officials.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Free Trade
â–ª Inward-oriented policies
(e.g., tariffs, limits on investment from abroad)
aim to raise living standards by avoiding
interaction with other countries.
â–ª Outward-oriented policies (e.g., the elimination
of restrictions on trade or foreign investment)
promote integration with the world economy.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Free Trade
â–ª Recall: Trade can make everyone better off.
â–ª Trade has similar effects as discovering new
technologies—it improves productivity and living
standards.
â–ª Countries with inward-oriented policies have
generally failed to create growth.
â–ª e.g., Argentina during the 20th century.
â–ª Countries with outward-oriented policies have
often succeeded.
â–ª e.g., South Korea, Singapore, Taiwan after 1960.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Research and Development
â–ª Technological progress is the main reason why
living standards rise over the long run.
â–ª One reason is that knowledge is a public good:
Ideas can be shared freely, increasing the
productivity of many.
â–ª Policies to promote tech. progress:
â–ª Patent laws
â–ª Tax incentives or direct support for
private sector R&D
â–ª Grants for basic research at universities
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Population Growth
…may affect living standards in 3 different ways:
1. Stretching natural resources
â–ª 200 years ago, Malthus argued that pop. growth
would strain society’s ability to provide for itself.
â–ª Since then, the world population has increased
sixfold. If Malthus was right, living standards
would have fallen. Instead, they’ve risen.
â–ª Malthus failed to account for technological
progress and productivity growth.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Population Growth
2. Diluting the capital stock
â–ª Bigger population = higher L = lower K/L
= lower productivity & living standards.
â–ª This applies to H as well as K:
fast pop. growth = more children
= greater strain on educational system.
â–ª Countries with fast pop. growth tend to have lower
educational attainment.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Population Growth
2. Diluting the capital stock
To combat this, many developing countries use
policy to control population growth.
▪ China’s one child per family laws
â–ª Contraception education & availability
â–ª Promote female literacy to raise opportunity cost of
having babies
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Population Growth
3. Promoting tech. progress
â–ª More people
= more scientists, inventors, engineers
= more frequent discoveries
= faster tech. progress & economic growth
â–ª Evidence from Michael Kremer:
Over the course of human history,
▪ growth rates increased as the world’s
population increased
â–ª more populated regions grew faster than
less populated ones
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
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ACTIVE LEARNING
2
Review productivity concepts
â–ª List the determinants of productivity.
â–ª List three policies that attempt to raise living
standards by increasing one of the determinants
of productivity.
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Cengage
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except
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ACTIVE LEARNING
Answers
2
Determinants of productivity:
K/L, physical capital per worker
H/L, human capital per worker
N/L, natural resources per worker
A, technological knowledge
Policies to boost productivity:
â–ª Encourage saving and investment, to raise K/L
â–ª Encourage investment from abroad, to raise K/L
â–ª Provide public education, to raise H/L
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Cengage
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May notMay
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except
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with a product
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ACTIVE LEARNING
Answers
2
Determinants of productivity:
K/L, physical capital per worker
H/L, human capital per worker
N/L, natural resources per worker
A, technological knowledge
Policies to boost productivity:
â–ª Patent laws or grants, to increase A
â–ª Control population growth, to increase K/L
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Cengage
2012 Cengage
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May notMay
be copied,
not be copied,
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except
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permitted
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in a distributed
license distributed
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with a product
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or service
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or otherwise
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Are Natural Resources a Limit to
Growth?
â–ª Some argue that population growth is depleting the
Earth’s non-renewable resources, and thus will limit
growth in living standards.
â–ª But technological progress often yields ways to
avoid these limits:
â–ª Hybrid cars use less gas.
â–ª Better insulation in homes reduces the energy
required to heat or cool them.
â–ª As a resource becomes scarcer, its market price
rises, which increases the incentive to conserve it
and develop alternatives.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
CONCLUSION
â–ª In the long run, living standards are determined by
productivity.
â–ª Policies that affect the determinants of productivity
will therefore affect the next generation’s living
standards.
â–ª One of these determinants is saving and
investment.
â–ª In the next chapter, we will learn how saving and
investment are determined, and how policies can
affect them.
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