Today I will once again digress from our macroeconomic analysis for some opportunistic politician bashing. As July 1st fast approaches, it’s becoming less and less likely that even our acrobatic Julia Gillard won’t be able to pull off the super backflip required to repeal the carbon tax. I was hoping I wouldn’t have to do this, but through some crafty economic graphing we can show you EXACTLY how the government is wasting your money. It’s not often that you can promise that. Once businesses have to pay a tax on their carbon emissions, they will inevitably raise their price to cover some of the cost. That’s not what this article is about. The government plans to use the money raised by the tax to reimburse households for the increase in prices that will occur, so it is often touted that overall, no one will suffer. This is of course rubbish and here’s why.
If you don’t like graphs and numbers don’t worry about the
colourful pictures underneath. All that you really need to understand is that:
the demand curve slopes downward (because as the price goes up, we as consumers
tend to buy less of a good) and the supply curve slopes upward (because as the
price goes up, those greedy producers tend to want to sell more). You can see
from graph A that at $8.00, people will want to buy two cars ie two cars will
be demanded, and further down the demand curve, if the price were only $6.00, four
cars will be demanded. The supply curve in graph B works the same way but in
reverse. At $5.60 suppliers will only want to sell 3.6 cars, but at $6.00 they
will supply 4 cars. (note however that the three demand curves in the graphs A,
B and C are all the same ie based on the same equation, and all three supply
curves are based on the same equation). Of course only one price and quantity
can arise in a market, and buyers and sellers get together and decide on the
price that results on the same amount being supplied that is demanded. That
price on our graph as you can see is $6.00, where four cars will be sold in our
market.
What’s important to notice for the purpose of implementing a
tax, is that some people would have bought a car even if the price of the car
was $8.00, and those people have only had to pay $6.00. In fact, based on the
demand equation used, if the price of a car were nine dollars, one car would
still be bought, implying that one person values a car at nine dollars. If the
price were eight dollars, two cars would have been bought. Yet all these people
only had to pay $6.00. This excess of “value received’ over “amount paid” is
called, oh yes; consumer surplus, and
you can bet by the end of this article, I plan to convince you that labor’s carbon
tax is gonna reduce it. One way to calculate consumer surplus is to work out at
each price how many cars would be sold, and calculate how much extra value was
received above the six dollar price that was paid. For example if the price
were nine dollars, one car is sold (implying it was valued at nine dollars) and
six dollars was paid for it, meaning an extra three dollars in consumer surplus
was enjoyed. At eight dollars, one more
car would be sold, meaning this car (valued at eight dollars) provided a
consumer surplus of two dollars. Doing this for every price will allow you to
calculate total surplus, however a better way is to calculate the area
underneath the demand curve, but above the price. This is the green shaded area
in Graph A, and is equal to $8.00 (the fact that this equals the $8.00 highlighted
on the vertical axis is purely coincidental).
In graph B you’ll notice that even if cars were sold for only $5.60, producers of cars would still wish to sell 3.6 of them, yet at the market price they are able to receive $6.00 for each car. As you can see, these producers are receiving a producer surplus of forty cents. Producer surplus is worked out by calculating the area above the supply curve but underneath the price: the yellow area in Graph B, equal to $8.00.
One of the cool things about having studied economics is
that you know the true “value” being traded in a market is not just the price
of a good multiplied by how many are sold. It’s not gonna get you laid or
anything, but it does gives you a useful tool for analysing the costs and
benefits of a lot of government intervention. The effect of a tax is to put a
wedge between the price that buyers pay and the price that sellers receive. The
government pockets the difference.
Assume the government decides to put an eighty cent tax on
every car sold. With a bit of algebra you can work out that, based on the
demand and supply curves we used, the price that buyers pay will be $6.40, and
the price that sellers receive after the tax is $5.60. 3.6 cars will be sold,
and what you end up with is a pretty little picture that looks like a triangle
house with elevator doors (in Graph C). At the higher price, less cars are
demanded by consumers, and the lower price received by sellers (after paying
the tax) means they wish to supply less cars. The resulting equilibrium in Graph
C shows how consumer and producer surplus have both shrunk to $6.48. The grey
area is represented by the tax collected by the government (eighty cents
multiplied by 3.6 cars). The reduction in surplus results because at the higher
price for consumers, some people won’t buy a car (and hence won’t have one),
and at the lower price received by suppliers some won’t sell a car (and hence
receive money for it). This area is highlighted in Graph C, in that most
relevant of all colours, red. The total loss in surplus is equal to sixteen
cents, or one percent.
Now we usually put up with some loss of surplus due to taxes
because the money raised can be used to provide useful goods and services that
the market generally won’t produce (roads, schools etc). However when all the
government is planning to do is give the money back, the reduction in surplus
is for nothing! This just goes to show that while in economics you can never
get something for nothing, in politics you can have something taken away, and receive
nothing in return. Such is the magic of government intervention.
So don’t let some polarised one minded labor lacky (and I
know liberal has them too) tell you that just because the government is giving
the money raised by the carbon tax back that no-one’s paying. We’re all paying.
And that’s before you take into account the hundreds of thousands of dollars of
administration costs wasted on operating a pointless tax. The next time they
tell you how important it is to return to surplus, ask them: what about my surplus? And this is
before you even begin to debate on whether or not this tax is necessary, but
that’s an article for another day.
2012-13 Budget
Labor government
Consumer surplus
Producer surplus
Budget surplus
