Question

1. Describe no graphs necessary how the income tax & social insurance taxes affect the labor market. Be sure to address what happens to wages, shifts in the labor supply/demand curves, changes in quantity of labor and deadweight losses, if any.
2. Define an externality. Give one example of a positive and negative externality. What do markets “look like” if externalities are not accounted for? (Address issues of market efficiency and deadweight losses.)

Answer 1

1.The rate of employment and hours worked are responsive to tax policies particularly in the early an late stages of life cycle.That is labour supply reduces with an increase in the income tax rate and social insuarance tax for their disposable income gets reduced,this in turn makes the supply curve of labour to shift left ward.So to keep the same amount of labour the firm has to pay an additional amount to offset the impact of the income tax,which otherwise mean an increase in wages.The increase in wages does not shift the demand curve towards left, but as the wage rate increases the demand for labour contracts and the new equilibrium where demand for labour intersects with the supply of labour, indicates less quantity of labour demanded and supplied in the labour market.

Taxes do create a deadweight loss for it prevents employment to that extent which could have been at a wage rate before the taxation.When supply and demand are not upto the potential it means the deadweight loss.The loss of something good in economic terms is the deadweight loss.

A benefit or a disadvantage of an economic activity which affect a third party,without this being reflected in the market price is called the externality.Or in other words it is the existance of an external benefit or an external cost.The positive externality is when the social benefit is greater than the private benefit (the price of the commodity).For example,the advantage of pollunation due to keeping the bees for honey.

The negative externality is when the social cost is more than the private cost ,i.e the existance of external costs.For example,pollution emmitted by a factory that spoils the environment,causing health problems to the surrounding society.

If there are no externalities the private cost will be equal to the social cost and the private benefit is equal to social benefit, that is the maximum market efficiency and no dead weight loss,