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23

students have signaled to landlords by their denv.nid increase that they simply value housing more than non-students. Without that signal, rental prices couldnt have responded at all, nor could the students have achieved greater living space. Far from complainmg about propert) owners greed for money, students might just as well complain about their own entireh greed) demand for increased space: The higher price of rental housing results from nothing more than the increased competition of students for housing space occupied by others. Landlords merely facilitate this compedtion. They have no power either to cause or prevent it. Indeed, students could not have the additional housing space they want if landlords responded any other way. In effect, landlords are criticized for responding to the very incentives that their equally greedy critics give diem.

EXCISE TAXES

While it may seem obvious that an increase in demand tends to raise price and quantit) consumed, sometimes the propositions derived from demand and supply curves are far less obvious. For example, many people would suppose that the imposition of an excise-tax of, say, $1 per pack of cigarettes would raise the market price by $1. Reference to a supply/demand diagram tells us that, in general, the proposition is false. Moreover, it also tells us the special circumstances under which the proposition is true. The analysis begins with a shift in supply.

Clearly, the effect of a $1 per pack excise tax is to shift the supplycurve upward by the full %\. Imagine you would be willing to supply 5 packs of cigarettes at a price of $7.00 per pack without a tax. thereby earn-

Flg. VII

Fig. Vlll

Fig. IX

Price Rises by Less Than $1

Price Rises by $1

Price Rises by $1

S+Tax

p,+6

---/i

/ S

/ ~ V*

/\ " / 1

1 1

02 Ql

demand curves and is given by D,. (You can ignore both the cur\es Dj and for now.) The equilibrium rent will initially be R<. as weve seen. Non-students will receive q,, units of rental housing and students qs-

We can see the hidden competition between these two groups by tracing dirough a demand increase. Suppose the University cuts tuition next term. Then presumably at least some students will want to improve their housing situauon, which is to say, students will increase their demand for housing, but non-students \n\\ make no changes. Just to keep the analysis clean, lets imagine an increase in demand by all students. Then the student demand Wu\ swing out to Ds, causing the market demand curve to swing out by an equal amount to D - Eventually Rg, the new rental price, will prevail not only for students whose demand has increased, but for non-students as well. In equilibrium the subjective value (marginal benefit) placed on the last unit of rental space is identical for both groups at the new rent, Re . Students will gain qs" 4s niore space but only through an exacdy corresponding surrender of space by competing non-students q - q. In this situation landlords are litde more than brokers reallocating housing space from low value users, non-students, to higher value users, something student tenants induced them to do by offering higher rents. But after the price increase, both groups will blame landlords for rent gouging and exploiting defenseless tenants; the local tenants union will complain to the Nexus that landlords costs havent risen, and new demands for rent control may also emerge.

Nobody will even think to criticize student tenants. Nonetheles.s, what has really happened is that



ing revenues of $35.00. Ifyou must now pay a tax of $1 on each pack sold, you will still insist upon receiving S35.00 for vour.self after paying total taxes of $5. But this nieans diat you will now require from bu\ers not S7.00, but $8 per pack in order to earn the same after tax re\enues of S35.00 from the sale of 5 packs, (ii.sequently, your supph cur\e has shifted upward by the full SI at 5 packs. Figure MI illustrates the poim; suppliers would inidally insist upon Pj for supplying quandty such as Q. But after the excise tax is imposed, diey would insist upon Pj + $1. \ we generalize to every other quantit) along the curve, we see that the supply curve shifts upward by the full SI.

However, at the price Pj + SI in the figure an excess supply of cigarettes exists. B\ the analysis in Section III, Pi+$1 could therefore not be the equilibrium price; radiei, price will fall until the new market clearance of Po is reached. Hence, in Figure VII the price goes up, but by less than the hdl SI. The consumers burden of the tax is the difference between what they pay before and after the tax. Before the tax consumers paid Pj, but after the tax they pay . Their burden is therefore P9 - Pi. The producers burden is the difference in what they receive before and after the tax. Before the tax producers received P but after it diey receive only P3 Their buiden is therefore P] - Ps. In the figure, some burden of the tax is borne by both.

The nvo special cases in which consumers pay the entire $1 occur when the demand curve is vertical as in Figure Vllt and also when the supply curve is completely horizontal as Figure IX. These results make intuitive sense. \Mien the demand is vertical con.sumers in effect declare that they would pay any price to ha\e Qj. In other words, consumers are willing to accept a price increase equal to the full amount ofthe tax. Since suppliers insist upon a price rise equal to the full tax as a condition for supplying Q,, the final price rises bv exacth that amount. Similarh, Avhen the supply curve is flat, suppliers insist upon P-tSl for supplying any outpm whatsoever. If demanders wish to buy anything at all, they must therefore accommodate themselves to that price,

Subsidies

Subsidies to producers have analviically .similai; but opposite, economic effects, .Again consider diat you would be willing to supply 5 pounds of peanuts at a price of $7.00 per pound. If the government now offers you a subsidy of $1.00 for ever\ pound sold, you will still insist upon coUecung S35.00 for supplying 5

pounds; In other words you would still require 87 qq per pound. But to achieve $7.00 per pound with the subsidy you will now insist upon only $6.00 fioin demanders. The rest comes from the subsidy Thus, a $1.00 subsidy will shift your supply curve downward by exactly $1.00 not only at 5 pounds, but at e\erv other quantity as well. We generalize to the whole market situation in Figure X, where the supply cur\c shifu downward by the full amount of the subsidy. ile the market price falls in the figure, it does so by less dian the full $1.00. Before the subsidy the market price was $7.00; after the subsidy the price falls to $6.50 rather dian j $6.00. The quandty sold rises from 5000 to 5500 units.

We now turn to the nvo special cases in which] a $1.00 subsidy causes the price to fall by the full Sl.OO.I The first case is shown in Figure XI where the marketj supply curve is totally flat and the demand curve has] the usual downward slope. Initially price and quandty] are P and Q. As before, the $1.00 subsidy shifts ihel supply curve down by exactly $1.00, so that the inaiketj price falls from P to P - $1. This result makes intuitix-a sense; since the supply curve is flat at P - $1, unliniitedl quanddes are available at that price. Therefor nobody would ever be willing to buy at above thafl price, nor are supphers willing to sell anything at It below that price. Hence P - $1 must be the new pr vailing price, which is to say that price falls by exact! $1. Note also that the quandt) sold rises from Q to Ql

A second case in which price falls by exactlv SI is illustrated in Figure XII where the demand curve i verdcal in defiance of the law of demand. .As in other two cases, the subsidy shifts the supph cur down by exacdy $1. Since the demand is \ertic the price falls to the lowest level at which supplieis ;

Fig. X The Impact of a Subsidy: The Usual Case

S - Subsidy

Q In Itiousands



Fig. XI Price Falls by $1.00

Fig. Xll Price Falls by $1.00

P-l$

willing to proride the Q units demanders so rigidly want. In contrast with the pre\ious two cases, the quantity sold does not change.

Since vertical demand curves are ruled out by the law of demand, wed normally expect a subsidy to increase consumpdon of the subsidized good. If the economy is operating along its production possibility curve, more consumption of the subsidized good assuredly means less consumption of something else; otherwise we could increase consumption of all goods without limit simply bv subsidizing them enough. Alas, } so long as we live in diis veil of tears, our limited pro-.ducthe resources preclude that happy day. Strangely enough, most people advocating subsidies for their favorite cause seem to forget this fundamental fact. If you doubt our word for it, the next dme you hear a speaker telling \ou we should subsidize one thing or another in order to have moi e of it, ask him what hes advocating we gi\e up to get it. The reaction will often be instructi\-e.

SPECULATION

Perhaps no t\pe of trading suffers from greater public misunderstanding than does speculation, i.e., trading in the hope of gain purely from change in mar-,jket prices. Since the speculator does not produce any- thing physical, it is sometimes wrongly thought that his profits are in some sense unearned. But this conclusion does not follow from the premises. On the contrary, speculators profit bv accepting ri.sks, a valuable senHce Ul itself Moreover, while stock or real estate traders are often speculation specialists, everyone speculates.

You, for instance, are speculating that the future . *alue of your UCSB education will exceed the opponu-

nity cost of acquiring it. You hope it will, but perhaps it wont. If it does, you win; if it doesnt, you lose.

Ifyou entered imo a lease on your apartment, you were speculating that yoiu- future rent will be lower under the lease than it would have been under a thirty day tenancy. Similarly, yom landlord was speculating that the rent under the lease would be higher than what he could get in a future thirt) day tenancy If when you went to the local grocer)- you stocked up on coffee because it was on sale, you were speculaung that the future price wont be even lower. If it isnt, you win; otherwise you lose.

Nonetheless, sometimes the most suident criticisms are heaped upon professional speculators by amateurs. Professional speculators, so the amateurs say, are parasites, profiteers who exploit the misfor-

Fig. xm

Price

Wittiout

Speculalion

X With

, Specutation

* Time



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