Market Interventions

1
Market Interventions Institutions

• Dr. Nikos Nikiforakis
• The University of Melbourne

2
Overview

• The purpose of this talk
• Part I To show how we can utilize theoretical
  tools to evaluate the effect of different
  policies.
• Part II To show the importance of experiments in
  evaluating different institutions
• Ultimately, the goal is to let you know some of
  the policy analysis that is out there and
  importance of experiments

3
Part I

• Market Interventions

4
Introduction

• Earlier on we saw that
• In a competitive market the equilibrium price
  (p) will be the one where quantity demanded will
  equal quantity supplied.
• p is the price that maximizes efficiency as all
  gains from trade are exhausted
• What happens to p and q as the economic
  environment changes?

5
Introduction

• We will discuss two types of policy
• Taxes
• Price controls
• Comparative statics change in equilibrium
  outcomes as a result of a change in economic
  environment.

6
Imposition of tax

• Different taxes (direct-indirect, value-quantity,
  progressive-regressive etc.)
• We will consider effects of a quantity tax on
  sellers (for further discussion see Stiglitz
  (2000))
• Quantity tax a tax levied per unit of quantity
  bought or sold
• For simplicity lets consider that there exist
  many buyers and sellers
• That is, demand and supply curves are straight
  lines

7
Imposition of tax
price
Supply curve before tax
Demand curve
e0
p0
quantity
q0
Example 1 Tax imposed to sellers
8
Imposition of tax
price
Supply curve before tax
Demand curve
e0
p0
quantity
q0
Example 1 Tax imposed to sellers
9
Imposition of tax
price
Supply curve before tax
Demand curve
e1
p1
e0
p0
quantity
q0
q1
Example 1 Tax imposed to sellers
10
Imposition of tax
price
Supply curve before tax
Demand curve
e1
p1
e0
p1- p0lt t
p0
quantity
q0
q1
Example 1 Tax imposed to sellers
11
Imposition of tax
price
Supply curve before tax
Demand curve
e1
p1
e0
p1- p0lt t
p0
ps
quantity
q0
q1
Example 1 Tax imposed to sellers
12
Imposition of tax
price
Supply curve before tax
Demand curve
e1
Consumer surplus
pb
e0
p1- p0lt t
p0
ps
quantity
q0
q1
Example 1 Tax imposed to sellers
13
Imposition of tax
price
Supply curve before tax
Demand curve
e1
Consumer surplus
pb
e0
p1- p0lt t
p0
ps
Producer surplus
quantity
q0
q1
Example 1 Tax imposed to sellers
14
Imposition of tax
price
Supply curve before tax
Demand curve
e1
Consumer surplus
pb
e0
Tax revenue
p1- p0lt t
p0
ps
Producer surplus
quantity
q0
q1
Example 1 Tax imposed to sellers
15
Imposition of tax
price
Supply curve before tax
Demand curve
e1
Consumer surplus
pb
e0
Tax revenue
p0
Deadweight loss
ps
Producer surplus
quantity
q0
q1
Example 1 Tax imposed to sellers
16
Tax in the first experiments
17
A Perfectly Inelastic Supply
Demand curve
price
Supply curve
e0
p0
quantity
q0
Supply cannot increase or decrease (at least in
the short-run). That is, supply curve wont be
shifted and market price (p0) will remain the
same. Therefore, all the tax will be paid by the
suppliers.
18
A Perfectly Inelastic Supply
Demand curve
price
Supply curve
e0
p0
p0 - t
quantity
q0
Supply cannot increase or decrease (at least in
the short-run). That is, supply curve wont be
shifted and market price (p0) will remain the
same. Therefore, all the tax will be paid by the
suppliers.
19
A Perfectly Inelastic Demand
Demand curve
price
Supply curve
e0
p0
quantity
q0
Demand will not react to price changes (important
drugs, cigarettes) As a result sellers will pass
along all the tax to the buyers.
20
A Perfectly Inelastic Demand
Demand curve
price
Supply curve
p0 t
e0
p0
quantity
q0
Demand will not react to price changes (important
drugs, cigarettes) As a result sellers will pass
along all the tax to the buyers.
21
Tax Liability-Side Equivalence
22
Tax Liability-Side Equivalence
price
Supply curve before tax
Demand curve
pb
p0
ps
quantity
TLSE says that it is irrelevant who is
responsible for paying the tax the equilibrium
price facing buyers and sellers will be the same
as the tax will be passed on.
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Tax Liability-Side Equivalence
price
price
Supply curve before tax
Demand curve before tax
Supply curve
Demand curve
p1
p0
p2
quantity
quantity
TLSE says that it is irrelevant who is
responsible for paying the tax the equilibrium
price facing buyers and sellers will be the same
as the tax will be passed on.
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Tax Liability-Side Equivalence

• Experimental evidence support TLSE (Borck et al.,
  2001 Ruffle, 2004)
• TLSE might not be clearly understood by some
  policy makers and civilians who confuse statutory
  with economic incidence.
• One explanation is that there is confusion
  between gross and net earnings. (See Ruffle
  (2004) for Canadian Conservative Party shift from
  a manufacturer to a consumer tax and Krugman
  (2000) discussion on Bushs gasoline tax cuts.
• Special cases if demand/supply are perfectly
  inelastic/elastic, i.e. if one of the curves is
  horizontal/vertical, then only one side will pay
  the tax.

25
Price Controls

• Term price controls refers to the imposition of
  a price floor, i.e. minimum price, or a price
  ceiling, i.e. maximum price.
• Recent example in Australia minimum wages in the
  labour market.
• What is the effect of such a policy?

26
Price Controls

• We saw that competitive markets maximize
  efficiency by exhausting all gains from trade.
• A price floor (like a price ceiling) will
  prohibit some of the trades and thus lower
  efficiency.

27
Price Controls
price
Demand curve
Supply curve
e0
p0
quantity
q0
28
Price Controls
price
Demand curve
Supply curve
pmin
e0
p0
quantity
q0
qs
qb
29
Price Controls
price
Demand curve
Supply curve
Consumer surplus
pmin
e0
p0
q0
qs
quantity
qb
Efficiency losses not only due to prohibition of
trades, but also due to anchoring effects (Falk
et al., 2006).
30
Price Controls
price
Demand curve
Supply curve
Consumer surplus
pmin
e0
p0
Producer surplus
q0
qs
quantity
qb
Efficiency losses not only due to prohibition of
trades, but also due to anchoring effects (Falk
et al., 2006).
31
Price Controls
price
Demand curve
Supply curve
Consumer surplus
pmin
e0
p0
Deadweight loss
Producer surplus
q0
qs
quantity
qb
Efficiency losses not only due to prohibition of
trades, but also due to anchoring effects (Falk
et al., 2006).
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Market Predictions
33
Market Predictions
34
Market Predictions
35
Market Predictions
Consumer surplus
36
Market Predictions
Consumer surplus
Producer surplus
37
Market Predictions
Consumer surplus
Deadweight loss
Producer surplus
38
Experimental Results
39
Experimental Results
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Summary (Part I)

• We saw how economic theory can help us predict
  the impact of imposing taxes and price controls.
• Experiments indicate that theory predicts well
  actual behaviour.
• Removing the price control does not necessarily
  improve efficiency due to anchoring effects (see
  Isaac and Plott (1981) for anchoring effects
  after price controls).

41
Part II

• Institutions

42
Introduction

• The Bank of Sweden Prize in Economic Sciences in
  Memory of Alfred Nobel 2002
• Vernon Smith for the use of laboratory
  experiments as a tool in empirical economic
  analysis, in particular, for the study of
  different market mechanisms.
• Institution Rules of the game
• Feasible actions
• Sequence of actions
• Information conditions

43
Introduction

• Does it matter if only sellers can post prices
  (like in retail markets)?
• Many institutions Double auction markets,
  English Auctions, Dutch Auctions, government
  grants.
• How can we compare performance Experiments

44
Posted Offer Markets

• Most retail markets in western countries
• Sellers quote prices on a take-it-or-leave-it
  basis
• Sometimes due to government regulation (shipping,
  alcoholic beverages)

45
Double Auction
46
Double Auction
47
Posted Offer
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Posted Offer
49
Summary (Part II)

• Institutions are important
• Experiments ideal in helping us evaluate which
  institution is optimal for each situation
• and to convince decision makers!!

50
AND NOW

• Before we decide which experiment will decide
  your payments you get to vote
• Average payoffs
• Experiment 1 37.17 Votes
• Experiment 2 35.29 Votes
• Experiment 3 22.00 Votes

51
Further reading

• Borck, R., Engelmann, D., Müller, W., Normann,
  H.T. (2001) Tax Liability-Side Equivalence in
  Experimental Posted-Offer Markets, Southern
  Economic Journal, 683, 672-692.
• Falk, A., Fehr, E., Zehnder, C. (2006) Fairness
  Perceptions and Reservations Wages - The
  Behavioral Impact of Minimum Wage Laws,
  forthcoming in Quarterly Journal of Economics.
• Isaac, M., Plott, C. (1981) Price Controls and
  the Behavior of Auction Markets, American
  Economic Review, 71, 448-459.
• Ruffle, Bradley J. (2005) "Tax and Subsidy
  Incidence Equivalence Theories Experimental
  Evidence from Competitive Markets", Journal of
  Public Economics, 898, 1519-1542.
• Stiglitz, Joseph. (2000) Economics of the public
  sector, Norton Co.
• Ketcham, J., Smith, V., Williams, A. (1984) A
  Comparison of Posted-Offer and Double-Auction
  Pricing Institutions, The Review of Economic
  Studies, 514, 595-614.