Assignment Example on Microeconomics

What is Laffer's theory?

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Laffer's theory shows the relationship between the tax rates and the resulting levels of government revenues. It demonstrates the concept of taxable income elasticity that is the rate of taxation changes in response to changes in taxable income. In simple terms, laffer's theory suggests that if the government reduces the levels of taxes imposed on individual income, more individuals will go to work and consequently government's tax revenue will increase (Mankiw, 2015).

Deadweight loss refers to the harm which a tax causes to economic production and efficiency. It is the degree in which taxes reduces the standard of living of the taxed population. Therefore it is essential to know that when a tax is imposed, it results in a higher purchase price in the market and reduces returns from rents, wages, and investments hence increasing the impacts of deadweight loss.

It is hard to estimate what will happen when taxes decrease or increase because of elasticity in the market. Elasticity in the market refers to a continual change in people's preferences and expectations. People's behaviours and expectations are unpredictable therefore it is difficult to determine what will happen when a tax rate is increased or decreased.

Describe both quotas and tariffs. How do they impact domestic prices and deadweight loss? How does an import quota differ from an equivalent tariff? What is best for a nation as a whole: a tariff, a quota, or free trade? Explain your answer.

Tariffs refer to the taxes charged on imported commodities. This means that tariffs usually increases the price of the goods in the domestic market. Furthermore, tariffs raise revenue for the government. Quotas, on the other hand, refers to the numerical limits charged on imported commodities. Import quotas usually produce surplus for companies that get authorization to import. It is vital to know that quotas usually harm consumers while benefiting the foreign and domestic producers.

Both import quotas and tariffs raise the domestic prices of commodities, reduce the amount of imports, increase the welfare of domestic producers, decrease the welfare of domestic consumers, and most importantly they cause deadweight loss (Mankiw, 2015). Deadweight loss occurs when both sellers and buyers of the commodities sustain losses that surpass the government revenue gained by the quotas and tariffs.

An Import quota produces a surplus for the importers while an equivalent tariff raises revenue for the government.

I believe tariffs are better for the country as a whole. This is because they prevent unfair competition, promote the local economy, helps retain jobs in the local economy and most significantly tariffs increase revenues for the government.

Although most economists agree that free trade is beneficial for a country, there are numerous arguments against free trade. Describe five of the arguments against free trade.

Arguments against free trade

1) Infant industry argument

New organizations sometimes need protection from the government against foreign companies. They require temporary trade restrictions to get started. But once they are fully equipped and ready to compete with foreign organizations, the government can now remove these restrictions.

2) National security argument

This is an argument against the free trade of vital goods such as steel. Steel, for instance, allows one nation to generate more weaponry and makes other nations more dependent on the steel-producing nation. Therefore, producers of steel tend to have a military advantage over other nations.

3) Unfair competition argument

Domestic market should be protected from unfair competition by both import quotas and tariffs. Free trade is only desirable if all nations play by the same rules.

4) The senile industry argument

Offering protection to inefficient and declining industries may act as an incentive for these firms to reinvent themselves. However, protectionism should not be used an excuse for protecting inefficient companies.

5) Jobs argument

Sometimes trade with other nations destroys job opportunities domestically. For instance, in events where domestic price is higher than the world price, local consumers tend to prefer imported goods hence making the domestic market to suffer losses which translates to a loss of job opportunities.

Describe the Coase theorem, which suggests that efficient solutions to externalities can be arrived at through bargaining. Explain how this happens. Under what circumstances does bargaining fail to produce a solution?

Coarse theorem suggests that in events where transaction costs are low, then two parties can bargain and reach an effective and efficient result in the presence of an externality (Mankiw, 2015). This happens when private parties can find solutions to externalities without government assistance. Bargaining fails to solve events where there is a huge number of interested parties.

Why do wild salmon populations face the threat of extinction while pet goldfish populations are in no such danger?

This is because pet goldfish is owned by private individuals while no one owns the wild salmon. Salmon is a public good which means that individuals can profit from killing, catching, and selling salmon for consumption. Goldfish, on the other hand, is a common resource which means that Goldfish owners have a profit incentive to breed goldfish to sell to consumers.

Define and explain the terms income tax and consumption tax. What would be the benefits of taxing consumption and not income?

A consumption tax is levied on services and goods that are consumed (Mankiw, 2015). It takes the form of excise, tariffs, sales taxes, and other taxes on consumer services and goods. In simple terms consumption tax is based upon consumption.

Income tax refers to the tax which is imposed directly on personal income. It is usually levied on both unearned income (rents, dividends, etc.) and earned income (salaries, wages, etc.)

It is important to tax consumption and not the income this is because it will encourage savings, create a level playing field, and finally it will bring in more taxpayers.

List the federal government's three most important sources of tax revenue. How do these differ from your state government's three most important sources of tax revenue and those of local government? Why do you think that these different government entities use different tax bases?

The federal government's most important sources of tax revenue include:

1) Individual income tax

2) Corporate income tax

3) Federal excise tax

Both my state and the local government raises revenue through a mix of corporate income, individual income tax, social insurance taxes, property taxes, and taxes on goods and services.

References

Mankiw, N.G. (2015) Principles of Microeconomics. CT: Cengage Learning