Government Actions in Markets
Figure 1
As a result of increasing the passenger movement tax on airlines, the equilibrium price P2 moves to new point P1. (P1>P2) The new quantity of flights is Q1. Therefore demand decreases, Q1 <Q2. Because of the increased prices some consumers denies to purchase tickets choosing other flight companies or using alternative ways of transportation.
A tax that is imposed on sellers in fact creates a burden on consumers as well because of the fact that consumers will be forced to pay higher prices. It is clearly shows on the Figure1 that the revenue from sellers equals the revenue from buyers.
It is shown that the impact of such a tax would have been identical had the tax been imposed on buyers instead. The demand for flights is elastic; therefore tax incidence is equal both for buyers and sellers. At the same time, imposing new tax means that buyer is to pay more than the seller receives.
The basic consideration to be taken by the government is that the efficiency of imposing tax depends on the shifts in demand. If the decreased quantity of goods does not seriously affect the profits received by the sellers providing government with additional financial resources. At the same time, the main principle of government policy to protect consumers may be defined as the main reason of implementing this tax.
Elasticity and Efficiency
a) Price elasticity of demand is indicator characterizing the response of consumer demand to changing prices of goods, i.e. consumer behavior when prices change. If price reduction leads to significant increase in demand, then this demand is considered
elastic.
b) The main factors influencing the price elasticity of demand for airfares are the availability of other airports with different conditions in Sydney, fare policies adopted by airline companies, time lag for adaptation to new prices, and the volume of financial resources of consumers.
c) As the result of elastic demand for the product the tax burden is allocated between sellers and consumers. If the demand was inelastic, only sellers would be subject to financial burden of taxation.
d) Allocative efficiency means economic situation when demand of customers is fully represented by manufacturers. The deadweight loss is the loss of surplus whether by consumers or sellers. The allocative efficiency may be reached in case additional support will be provided to customers and sellers to minimize the negative effect of the tax burden.
3. Consumer Theory
a) The indifference curve for substitutes shows that the consumer purchases either good K or good F. The MRS equals 2. The curves show the different volumes of consumption of both goods. (If good F is consumed, the consumption of good K equals zero and vice versa)
Figure 2 Indifference curve for substitutes
b)
Figure 3 Indifference curve for complements
The diagram clearly shows that with the increase of consumption of good K, the consumption of good F as these goods are perfect complements.
c) The indifference curve represents the same aggregate utility of various benefits for the consumer. Indifference curve (U) consists of points that represent the sets of goods X and Y. Total utility of all sets represented by points on this curve are the same, i.e. the consumer is indifferent to which combination of goods X and Y is to choose. Going from point A to point b, the consumer decreases consumption of good Y for ΔY and increases consumption of good X, but the overall level of total utility remains unchanged. The marginal rate of substitution is constantly diminishing as MRS equals (-▲Y/▲X). The moving along the curve AB leads to the decreasing of ▲Y and increasing of ▲X.
4. Consumer Theory
a) The rule of maximization of utility means that the income of the consumer must be distributed in such a way that the last dollar spent on each product or service brought equal marginal utility. This rule may be expressed by the formula MU(A)/P(A)=MU(B)/P(B).
b) As the result of imposing tax on the good K, its consumption will decrease. The indifference curve I2 moves to the curve I1. It means that the overall utility level decreases minimizing benefits of customer. The consumption of good F will be the same.
c) Demand for Good K is derived from the part b of this assignment. P1 - is price before taxation and P2 is increased price (after taxation).
The substitution effect is the change in the structure of consumer demand as a result of changes in the price of one of the goods included to the consumption set. The income effect means that the increase of price of Good K is equivalent to decrease of his real profits. (the new budget level)
5. Externalities
a) The negative externalities in this case may be expressed in the fact that other passengers that are unsatisfied may refuse to purchase the services in future.
b)
b)
c) The main equation is that the marginal social benefit should equal the marginal social cost. The actual equilibrium level (Pp; Qp) does not reflect the social cost. The price should be increased to the level Ps (ideal equilibrium).
d) The increase of price for the product (Pq-Ps) is the best solution of the outcomes of negative externalities. Such increase is likely to be achieved as the result of imposing tax.
6. Externalities
a) The situation described is related to positive externalities that provide consumers with additional benefits.
b)
c) The main equation is that the marginal social benefit should equal the marginal social cost. The actual equilibrium level (Pp; Qp) does not reflect the social cost. The equilibrium is still inefficient. The price should be increased to the level Ps (ideal equilibrium).
d) As the result of positive externalities, consumers start to purchase too much touristic services. The supply is unready to meet the demand. The prices should be increase by the means of taxation to force companies to provide additional services.
