Monday, November 1, 2010

Column: How Can We Help?

by Martin Kennedy

I'd argue that the general understanding of economic concepts has improved over time. Policymakers are better informed regarding fundamental economic concepts. (Various policies that are condemned by most economists persist due to rent-seeking behavior — some policies benefit an organization or industry even as they reduce overall efficiency.)

Economists do sophisticated research, but what simple concepts — if better understood — would improve policy formation?  A better understanding of deadweight loss is one place to start.  I like the following from Economist Tyler Cowen (George Mason University).

Imagine that you want to go to New York on a trip.  You value the trip at $50, and a bus ticket costs $40.  Do you take the trip? 
A. Yes.  The value ($50) of the trip exceeds the cost of the ticket ($40), so you travel to New York.

How much consumer surplus (net value) do you get from the trip? 
A. $10=$50-$40. 
The government taxes bus tickets, which raises the price of a bus ticket to $60.  Do you take the trip? 
A. No. The value of the trip is now less than the price of the ticket. 
What happened to the $10 consumer surplus you used to get when there was no tax? 
A. It's gone since no trip takes place. 
Did the government get any tax revenue from you? 
A. No.  
Key Idea: Consumers lose, but the government does not gain, from trips that are not taken.
Conclusion: Deadweight loss is the value of the trips (trades) which do not happen because of the tax.

Martin Kennedy

Martin Kennedy teaches economics at MTSU. In this column he will discuss business news. Views expressed are not necessarily those of the Jones College. He invites reader input. 

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