Taxes, Price, & Quantity Controls

Taxes, Price, & Quantity Controls

• Taxes are mandatory contributions that are levied on individuals or corporations
• Taxes are collected by a government entity at the local, regional, or national level
• In economics, the tax burden falls on whoever remits the tax, whether it be the business or consumer
• Tax revenues help finance government activities such as public works, schools, social security, and Medicare

Types of Taxes

• Income tax refers to a percentage of generated income relinquished to the state or federal government
• Payroll tax is a percentage withheld from an employee's pay by an employer, and given to the government to fund Medicare and social security programs
• Corporate tax is a percentage of corporate profits taken by the government to fund government programs
• Sales tax is levied on certain goods and services and varies by jurisdiction
• Property tax is based on the value of land and property assets
• Tariffs are taxes on imported goods designed to strengthen domestic businesses
• Estate tax is a rate applied to the Fair Market Value (FMV) of property in a person's estate at the time of death
• Estate tax is only applicable when the total estate exceeds thresholds set by state and governments

Elasticity and Tax Revenue

• Elasticity reveals whether forms can pass higher costs that they incur to consumers
• Tax incidence is how the tax burden is divided between buyers and sellers
• Tax incidence depends on the relative price elasticity of supply and demand
• When supply is more elastic than demand, buyers bear most of the tax burden
• When demand is more elastic than supply, producers bear most of the cost of the tax
• When tax revenue is larger, the more inelastic the demand and supply are

The Burden of Tax

• Depending on the circumstances, the burden of tax falls more on consumers or producers
• With cigarettes, demand is inelastic due to their addictive nature
• Taxes are mainly passed to consumers as higher prices
• Tax incidence is the analysis, or manner, of how the burden of a tax is divided between consumers and producers
• The incidence or burden of a Tax falls on the consumers and producers of the taxed good
• To predict which group will bear the most of the burden, one must examine the elasticity of demand and supply
• Consumers bear most of the tax burden if demand is more inelastic than supply
• Sellers bear most of the tax burden if supply is more inelastic than demand
• An excise tax generates low revenue in a market where both demand and supply are very elastic
• Excise taxes hurt specific industries
• Whether the tax burden falls mostly on the industry or consumers depends on the elasticity of demand and supply.

Flavors of Price Control

• Price controls are laws that the government enacts to regulate prices
• Price controls are enacted when government laws regulate prices instead of letting market forces determine prices

Price Ceiling

• A price ceiling keeps a price from rising above a certain level
• They are mandated maximum amount sellers can charge for a product or service
• Price ceilings are typically applied to staples, such as food and energy products, when such goods become unaffordable to regular consumers
• Price ceilings can be advantageous by allowing essentials to be affordable, at least temporarily
• Economists question how beneficial price ceilings are in the long run
• When a price ceiling is set below the equilibrium price, quantity demanded will exceed quantity supplied and excess demand or shortages will result
• Advantages of a price ceiling include limiting costs for the consumer, keeping things affordable, and prevents price-gouging
• In the event of a temporary shortage that's causing rampant inflation, ceilings can mitigate the pain of higher prices until supply returns to normal levels again
• Price ceilings can also stimulate demand and encourage spending
• Disadvantages of price ceilings include often causes supply shortages, may induce loss of quality, may lead to extra charges or boosted prices on other goods
• Some producers may be driven out of business if they can't realize a reasonable profit on their goods and services

Price Floor

• A price floor keeps a price from falling below a certain level
• It is the minimum price imposed by a government or agency for a particular product or service
• An effective price floor needs to be higher than the equilibrium price, which is the price at which supply and demand are equal
• Without an effective price floor, the market would not sell below the equilibrium, and the price floor would mean nothing
• Sellers who charge a price lower than the imposed floor price would be breaking the law
• When a price floor is set above the equilibrium price, quantity supplied will exceed quantity demanded, and excess supply or surpluses will result
• The effect of a price floor on producers can be ambiguous
• Producers may be better off, no different, or worse off as a result of the measure
• The effect of a price floor on consumers is more straightforward
• Consumers never gain from the measure; they may be worse off or no different

Types of Price Floors

• A binding price floor is greater than the equilibrium market price
• A binding price floor creates a disequilibrium because it excludes those who are purchasing the item at a lower price than the market would otherwise allow and creates a surplus
• An example of a binding price floor by law is the minimum wage
• Companies must pay their employees at or above the designated minimum wage or risk legal sanctions through the department of labor
• A non-binding price floor is lower than the equilibrium market price
• The non-binding price floor does not affect the market
• The market price remains P* and the quantity demanded and supplied remains Q*
• Producers and consumers are not affected by a non-binding price floor
• Governments usually set up price floors to assist producers
• Governments may establish a price floor in the coffee bean market to encourage production
• Governments put in place price floors in markets with inelastic demand and very low prices naturally
• The practice allows the government to increase overall welfare in the society as the gain for producers more than offsets the loss of consumers

Summary of Price Ceilings and Price Floors

• Price ceilings prevent a price from rising above a certain level
• Quantity demanded will exceed the quantity supplied and excess demand or shortages will result when a price ceiling is set below the equilibrium price
• Price floors prevent a price from falling below a certain level
• Quantity supplied will exceed quantity demanded, and excess supply or surpluses will result when a price floor is set above the equilibrium price
• Price floors and price ceilings often lead to unintended consequences

Concept of Cost

• Physical inputs or resources are important for enhancing production
• Some of the most important decisions pertaining to business often relate to the cost of production
• Cost refers to the amount paid to acquire any good or service
• Cost also encompasses the financial valuation of resources, materials, undergone risks, time and utilities consumed to purchase goods and service

Types of Costs

• Accounting Costs and Economic Costs
• Outlay Costs and Opportunity Costs
• Direct/traceable Costs and Indirect/untraceable Costs
• Incremental Costs and Sunk Costs
• Private Costs and Social Costs
• Fixed Costs and Variable Costs

Concepts of Costs in terms of Treatment

• Accounting costs are costs for which the entrepreneur pays direct cash for procuring resources for production
• Include costs of the price paid for raw materials and machines, wages paid to workers, electricity charges, the cost incurred in hiring or purchasing a building or plot
• Accounting costs are treated as expenses
• Accountants record accounting costs in financial statements
• Economic costs are certain costs that accounting costs disregard
• Economic costs are money the entrepreneur foregoes but would have earned had they invested his time, efforts and investments in other ventures
• May include potential returns on the capital employed in his business instead of giving it to others or output generated by his resources which he could have used for others’ benefits
• Help the entrepreneur calculate supernormal profits/profits they would earn by investing in other ventures

Concepts of Costs in terms of Expenses

• Outlay costs are actual expenses incurred by the entrepreneur in employing inputs
• Outlay costs include costs on payment of wages, rent, electricity or fuel charges, raw materials, etc
• Outlay costs are treated as general expenses for the business
• Opportunity costs are incomes from the next best alternative that is foregone when the entrepreneur makes certain choices

Concepts of Costs in terms of Traceability

• Direct costs are related to a specific process or product
• They are also called traceable costs because they can be directly traced to a particular activity, product or process
• Direct costs can vary with changes in the activity or product
• Examples of direct costs include manufacturing costs relating to production and customer acquisition costs pertaining to sales
• Indirect costs are those which do not directly relate to a specific activity or component of the business
• An increase in charges of electricity or taxes payable on income is an example of an indirect cost

Concepts of Costs in terms of Purpose

• Incremental costs are incurred when the business makes a policy decision
• A change of product line, acquisition of new customers, or upgrading of machinery to increase output are incremental costs
• Sunk costs are costs that the entrepreneur has already incurred, and they cannot recover them
• Money spent on advertising, conducting research, and acquiring machinery are examples of sunk costs

Concepts of Costs in terms of Payers

• Private costs are those that are incurred by the business in furtherance of its own objectives
• Entrepreneurs spend private costs on their own private and business interests
• Social costs are borne by the society for private interests and expenses of the business
• Social costs include social resources for which the firm does not incur expenses, like atmosphere, water resources and environmental pollution

Concepts of Costs in terms of Variability

• Fixed costs do not change with the volume of output
• The business incurs them regardless of their level of production
• The payment of rent, taxes, and interest on a loan are examples of fixed costs
• Variable costs vary depending upon the output that the business generates
• The business will pay more when its production is greater and less production will cost fewer expenses

Solved Examples on Concept of Costs

• The cost incurred in advertising is an example of a direct cost because its traceable to sales
• The cost incurred in advertising is an example of a sunk cost because it is not recoverable
• The cost incurred in advertising is an example of a private cost because its spent for business interests
• The cost incurred in advertising is an example of a variable cost because it will vary depending on the volume of output
• Income earned from a job is an economic and opportunity cost because the person could earn more by working for his business
• Rent paid for factory premises is an example of an accounting cost because its spent on procuring facilities for production
• Rent paid for factory premises is an example of a direct cost because it directly affects manufacturing
• Rent paid for factory premises is an example of an outlay cost because it spent on procuring access to input
• Rent paid for factory premises is an example of a private cost because its used for private business interests
• Rent paid for factory premises is an example of a fixed cost because it does not change with variance in production levels
• Costs are an integral part to the field of economics because economics studies choices
• Decisions are based on weighing unlimited wants with limited resources to achieve the things that are desired
• We cannot make decisions without considering costs, and the study of economics would be at a loss without considering them highly
• In everyday life for individuals, business and corporations, cost-benefit analyses are carried out
• Every time you make a purchase, you do after a cost-benefit analysis
• If the cost was too high, you wouldn't have taken steps to procure it
• If the benefit is high, you might pay more than you would for another object with fewer benefits
• These decisions involve weighing costs against benefits

Market Structure

• In economics, market structure refers to how different industries are classified and differentiated based on their degree and nature of competition for goods and services.
• Market structure is based on the characteristics that influence the behavior and outcomes of companies working in a specific market
• Market structures show the relations between sellers and other sellers, sellers to buyers, or more

Determinants of Market Structures

• These include the nature of the goods and products, the number of sellers and consumers, the nature of the product or service, and economies of scale

Economies of Scale

• Economies of scale refers to the cost advantage experienced by a firm when it increases its level of output.
• The advantage arises due to the inverse relationship between per-unit fixed cost and the quantity produced.
• The greater the quantity of output produced, the lower the per-unit fixed cost.

Types of Market Structure

• These include perfect competition, monopolistic competition, oligopoly, and monopoly

Perfect Competition

• Perfect competition is when there are a large number of buyers and sellers
• All the sellers of the market are small sellers in competition with each other
• There is not one big seller with any significant influence on the market
• All the firms in such a market are price takers
• It is practically a theoretical concept
• Products on the market are homogeneous
• Products on the market are completely identical
• Firms only have the motive of profit maximization
• Free entry and exit from the market
• There are no barriers
• There is no concept of consumer preference

Monopolistic Competition

• Monopolistic competition is a more realistic scenario that actually occurs in the real world
• There are still a large number of buyers as well as sellers
• Does not sell homogeneous products
• The products are similar, but all sellers sell slightly differentiated products
• Consumers have the preference of choosing one product over another
• The sellers can also charge a marginally higher price since they may enjoy some market power
• Sellers become the price setters to a certain extent

Oligopoly

• An oligopoly is when there are only a few firms in the market
• 3-5 dominant firms are considered the norm even though there is no clarity about the number of firms
• The buyers are far greater than the sellers
• Firms in an oligopoly either compete with one another to collaborate together
• Use their market influence to set the prices and in turn maximize their profits
• The consumers become the price takers
• There are various barriers to entry in the market, and new firms find it difficult to establish themselves

Monopoly

• A monopoly is when there is only one seller, so a single firm will control the entire market
• Monopolies can set any price it wishes since it has all the market power
• Monopoly consumers do not have any alternative and must pay the price set by the seller
• A profitable monopoly could only exist if there were barriers to entry
• A patent can give the patent owner a legal monopoly on the production of the patented product, for example
• This type of market is characterized by factors such as the sole claim to ownership of resources, patent and copyright, licenses issued by the government, or high initial setup costs

Market Structure Conclusion

• Market structure is important because it leads to strategic decision making
• Knowing market structure impacts decision making because organizations will learn the characteristics of their competition and how the market will respond to changes

Competitive Environment

• A competitive environment is a system where different businesses compete with each other
• Businesses compete by using various marketing channels, promotional strategies, pricing methods, etc
• This system has regulations within it that companies should follow
• It is the dynamic external system in which a business competes and functions
• The more sellers of a similar product or service, the more competitive the environment in which one competes
• It is an environment where companies and nations have the opportunity to compete effectively with one another considering the regulations in the environment

Firm's Competitive Environment

• A firm’s competitive environment includes components inside the firm and outside the firm

External Factors

• External factors are things in the global environment that may impact a firm’s operations or success
• A rise in interest rates or a natural disaster are examples of external factors
• External factors cannot be controlled, but they must be managed effectively and understood so the firm can be successful
• Labor is an example
• Unemployment rates will affect a firm's ability to hire qualified employees at a reasonable rate of pay
• High unemployment rates means many people are looking for jobs, resulting in a firm having a lot of applicants to choose from

Internal Factors

• Internal factors are characteristics of the firm itself
• A firm needs to understand its physical, financial, and human resources, what it is good at, and how it is organized to plan to compete against other firms
• Walmart uses a sophisticated system that tracks inventory and automatically orders products before they run out and compares it to the rate at which the product sells off the shelves
• Walmart does not have to spend money on storing or keeping track of inventory, all products in the store can generate revenue because they are available for customers to buy, and the store never runs out of items customers want when the system is working optimally

Competitors Affect Business

• Competitors can directly affect your business and the decisions you make
• A competitive environment also has a positive effect on customers
• Businesses often offer high-quality goods at an affordable price to win consumers' attention
• Companies have to bring out the best in their products through innovations

Types of Competitive Environments

• Includes Pure Competition, Monopolistic Competition, Oligopoly and Monopoly

Pure Competition

• In a perfectly competitive environment, many small companies produce similar products, and many consumers buy them
• These manufacturers are small and cannot influence the price, which is defined by supply and product demand
• When a farmer brings dairy products to the local market, they cannot change the market price and agrees with the going one

Monopolistic Environment

• Many manufacturers produce different products that serve the same purpose
• Customers can distinguish the products because of the differences in quality, features, etc
• Businesses actively use advertising to promote their products and convince consumers that they are not like other products and have better quality
• Companies in monopolistic competition can influence the product price
• They should offer something exclusive to be unlike other businesses and to improve the quality of their goods to justify the price increase of their products

Oligopoly

• There's a small number of businesses in this market model
• It's considered stable as companies do not compete but collude to obtain high market returns
• Firms set and keep prices high together or under the leadership of one particular company
• Profit margins are higher in an oligopoly than in a more competitive environment
• The main problem of this market structure is that businesses often face a prisoner's dilemma, where there is an incentive to cheat and act in their interests at the expense of other companies

Monopoly

• There is only one company that produces a unique product
• There is no competition and the product doesn't have any substitutes
• A monopolist decides on the product's price and sets barriers for new companies to enter the market

Porters 5 Forces

• Porter’s analysis of the competitive environment isn’t complex
• It’s straightforward and easily understood
• Competition in a given industry depends upon the interaction of five separate forces

Porter's Five Forces

• The five forces are The threat of entry, supplier power when many Buyers, buyer power when many Suppliers, the threat of substitutes and the threat of competitor rivalry

Threat of Entry

• Competitors can arise from more than one area
• In an industrialized economy, a company can make a strategic decision to enter an area for many reasons, among them being an underserved area, unusually high profit margins, and a benefit from entering with a patented process or product that gives them a unique advantage
• Supplier power when many buyers, supplier will dominate and command a greater share of profits when their are only a few sources of supply but many buyers
• China's strategy for solar panel cells is based on driving prices down low enough that suppliers in countries with higher labor costs and cannot compete. Leaving China able to control profits throughout the industry

Buyer Power when many Suppliers

• Where there are only a few buyers and many suppliers, buyers will dominate and will control supplier's profits
• Apple has more than 200 Chinese component suppliers for its iPhone
• Competition among these suppliers for a single buyer has repeatedly driven down supplier prices, resulting in worker mistreatment and forced long hours without breaks under difficult conditions
• Apple’s largest Asian supplier has been caught using student interns and forcing them to work overtime without overtime pay in an effort to maintain market share
• Apple has been criticized for the situation and has made some attempts to ensure equitable working conditions for workers in these factories

Threat of Substitutes

• Threat of substitutes is another competitive threat comes from the availability of substitutes for a company's existing product
• The pharmaceutical industry's devises strategies to hold off the entrance into the marketplace of generic drugs

Threat of Competitor Rivalry

• Porter’s fifth force is the cumulative effect of the first four

Other Competitive Threats

• Competition can come from anywhere, including innovative new products, new suppliers or buyers who control the marketplace, and product substitutions
• Competition can also arise from deregulation, innovation or more cost-efficient industrial processes, and innovative technology and/or a lower-cost labor force

Conclusion

• Businesses need to look beyond existing products, the current shape of the marketplace and the current competition and to focus on where competition may come from in the near and intermediate future
• Overlooking latent and emerging competitive sources will cost businesses future market share or even – as was the case with polaroid – the survival of the company

Factors to Consider in Identifying Business Opportunities

Analysis of Internal Demand

• Analysis of Internal demand determines the possibility of future demand of identified existing and proposed products.
• Prior to analysis, the entrepreneur will factor in the per capita income, population, and national income.

Availability of Raw Materials

• Easy availability of raw material also has an important role in selecting the business opportunities
• Quantity and level of future production are therefore decided by raw material availability
• If the raw material is easily available, then not only the production cost is low, but it also readies the entrepreneur to establish the industrial unit

External Assistance

• External assistance from government, suppliers, investors, and specific institutions is important for the identification of business opportunities
• External assistance, support and cooperation are helpful in identification of opportunities.

Knowledge about Industrial Development

• By obtaining detailed knowledge about proposed industrial development from various sources, the entrepreneur may know the establishment of which type of industry and at which place will be profitable

Internal Sources

• The availability of internal sources also has an important role in the identification of business opportunities
• May result in positive steps for the establishment of the industrial unit if the sources of production are regularly available

Performance of Existing Units

• The entrepreneur analyzes the performance of existing units
• Involves analyzing products, product expansion, capital, profits, employment, assets, and export possibilities

Promote Entrepreneurial Activity

• Entrepreneurs may promote entrepreneurial activity for the establishment of industries having good potential for exports, by identifying suitable business opportunities
• Decisions regarding the profitability, or in which specific areas are industries and opportunities for promotion are available may be taken on the basis of study and analysis of the aforesaid factors