Class Thirty Five

When you make something illegal, you don’t eliminate the want; instead, you raise the opportunity cost of suppliers. There is additional cost that doesn’t show on the supply and demand picture.

When you make something illegal, you have to enforce law. Illegal requires enforcement. To do that requires two costs, one not so bad, one really bad:

i.                     (Not so bad) you have to raise taxes to do it. (Tax is not costly itself, it’s just a transfer. The act of raising tax is costly)

ii.                   (Really bad) These bureaucrats can do other things that are productive. (This is really costly)

Consequences:

i.                     when you make a certain profession illegal, the job participants don't have to pay payroll tax, insurance money. They can get more pure profit, even exceeding the increasing cost. (the original and the new supply curve may intersects) The supply curve may actually shift out, even if it becomes more inelastic (price goes down): precisely the opposite that you want to see.

ii.                   There’s a strong correlations between crime rate (the big profit entices more people to join and compete) and drug law enforcement.

If we punish severely on some small sins, like smoking in the bathroom, we actually lower the marginal cost for people to commit the severe crimes.

Some people say that one of the benefits when prostitution is legalized is that government can get tax for revenue. But this opinion is odd:

i.                     Tax itself is neutral; it’s just a transfer of wealth from private sector to public sector, so no one gets benefit or hurt. It’s neither cost nor profit.

ii.                   Why is government tax revenue benefit? The signal of wealth is not how much money the government has but how many goods and services people produce.

The economic incidence of supply and demand curve
Application: Taxation

1. Excise tax: legal liability for tax is upon suppliers
the result of a tax
(1) customers and suppliers share the burden of tax and the more inelastic, the more loss the group has to suffer
(2) if the tax is $1, price doesn't go up by $1. Reason: both demand curve and supply curve usually have a slope (equilibrium quantity decreases, causing deadweight loss)
(3) The government cannot get as much tax revenue as it intended to get because of the second reason.
(4) The market is affected. Deadweight loss occurs (the forgone opportunity)
(5) We have to hire bureaucrats to enforce the law, but they don't produce anything new.
(6) People can cheat on tax
<a> they have to waste resources to avoid the tax
<b> others have to pay for your tax

The economic incidence of supply and demand curve

A way for a free market to get efficiency and equity at the same time
Head Start Theorem (Kenneth Arrow)
An appropriate program of lump-sum taxes or subsidies that puts everyone on equal footing.