Class Summary #39 for 12/5/11

Today, we finished up our discussion on the economics of making certain things illegal. Then, Prof. Rizzo began to get in to the study of economics and taxation. He posted two supply and demand curves on the blackboard to discuss, but only had time to go over one of them. We'll be going over the other on Wednesday.

To start with the Drug Market and making drugs illegal:

1. When drugs become illegal, buyer behavior doesn't change. Seller's behavior does. Thus, the supply curve would become more elastic and the curve would become more vertical.
2. A perfect comparison as to why the potency of drugs increases when drugs are made illegal: look at 1920s prohibition. The potency of alcohol in the 1920s was much stronger during that time than it is now.
3. There are two main costs that go into effect for people to maintain illegality of a drug (having police forces, etc. to monitor and make sure no one does anything illegal).
1. Increase in taxes.
2. Millions of people are engaged in preventing bad behavior. Rizzo did not say this was wrong but it is indeed costly to do this (like #8 from our list in class from last week). It is costly (huge opportunity cost) because people are wasting time monitoring when if everyone just did what they were supposed to do, these monitors could be out producing and making things better for us in society.
4. An interesting statistic:
1. The US government spends $33 billion (this is not taking into account added opportunity costs) and arrests 1.5 million people annually to fight against illegal drug use.
5. On the other hand, maybe it is good to ban drug use: When drugs are illegal, there is no cost of production anymore. In other words, there are no jobs necessary for making marijuana, etc. So this saves money and those people can go do more productive jobs. This could cost the supply curve to shift out.
6. There is also a strong correlation with drug enforcement and violence. There is more violence with more drug enforcement. Some studies suggest we could reduce homicides by 75% in US if we legalized drugs.
1. Possible reasoning for why there is more violence with more drug enforcement? It is because it changes incentives. Take a look at the 3 strike policy in California. If you are caught doing something bad on 3 separate occasions, you automatically go to jail for 15-20 years regardless of what you did wrong. So, let's say a person is smoking marijuana in the bathroom and someone comes in to the bathroom and says he is going to report the marijuana smoker to authorities. Well, now look what happens: the marijuana smoker does not want to risk getting in trouble and get a strike, so he beats the crap out of the other guy. He does this because there is ultimately no marginal cost to, as Rizzo puts it, "beating his ass". If he "beats his ass", the man might go to jail for a year. If he lets him go tell on him though, he will go to jail for 15-20 years. Thus, violence increases.

Then we learned about "The Economic Incidence of Supply and Demand Changes.

Here is a table we wrote out for graph A that tells a lot about the impact of taxation:

                               Buyers                              Sellers

Initial Price               $3.00                                 $3.00

Final P                     $3.75                                $3.75

Tax paid                       ----                                $1.00, so make 2.75

Economic burden     75 cents                              25 cents

So here was the scenario: the government wants to levy a tax on bubble gum sales. They decide to charge a $1 tax per pack of gum sold, but the tax has to be paid by the companies selling the gum, not the buyers.

So as a result, companies raise gum prices from $3.00 to $3.75 to account for the tax. If you look at the table above, this makes gum 75 cents more costly for buyers and 25 cents more costly for sellers. Thus, the tax has a greater effect on buyers in terms of monetary burden. Thus, sellers are ultimately bearing the cost of tax.

This new price of gum causes a new EQ on the supply and demand curve. If you look at the curve though, we can see that this tax drives a wedge between buyer and seller. The tax prevents other good transactions from taking place.

Important phrase: Excise Tax= the legal liability for the seller to pay the tax. The seller has to write the tax check to the government. He has a legal obligation to do so. This would thus effect the supply curve.

IMPORTANT: When economists say taxes are bad, they mean what is known as dead weight loss, and not the price increase. What they mean is that taxes prevent transactions from taking place. Thus, this results in there being less jobs and wealth. For this reason, the government and society has to be careful with what and when we tax because we want to minimize the aforementioned scenario from happening as much as possible.

Finally, some interesting statistics/info about this topic:

1. $1.2 trillion lost a year by US government because we tax inefficiently and thus prevent transactions that otherwise would have taken place. It is almost counter productive. This amount of money is the entire Australian economy. We can say that in a way, we destroy the equivalent of one Australia every year.
2. Also, remember that it costs resources to collect taxes. Jobs and people have to be paid for collecting taxes. Specifically, the US government spends 41 cents every $100 collected for taxes on paying the IRS, even though the IRS produces nothing of value. They are not PRODUCING anything, just collecting. The IRS might be necessary, but it is of no value if people could just be responsible and send in their tax money, since the IRS employs 115,000 people.
3. This dead weight loss from #2 is separate from tax fraud. Tax fraud is also costly to society because people are wasting their time figuring out how to cheat the rules instead of producing something of value to society (back to #8 from class last week).