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Question 1

a) The bonus payment cap on the labour market would impose a price ceiling on labour in the
market. Assuming the price ceiling is below the equilibrium price as shown in Appendix A1,
this would result in a decrease in quantity supplied, i.e. members of the workforce seeking
work as CEOs, and quantity demanded, that is number of positions available, would increase
in lieu of the decrease in cost of labour. Hence this would result in a shortage in the market
as quantity demanded is higher than quantity supplied.

b) The tax proposed would shift the supply curve to the left as due to the increase in tax which
would be imposed upon workers, workers would then be less inclined to work. Thus, it can be
seen in Appendix A2, the equilibrium quantity would decrease and the equilibrium price
increase. Due to this, the cost of hiring would increase, so CEOs would then have a higher paid
income. Despite this, the increase in income paid is offset by the increase in tax, shouldered
by both the demand and supply side of the labour market as shown by the shaded area.

c) The unlikeliness of the tax hike reducing incentive to earn suggests that the supply side of
labour is inelastic. Therefore, the suppliers of labour will burden most of the tax, thus
suggesting of a tax hike more appealing to the public. The proportion of tax shouldered by the
demand and supply side of labour is shown in Appendix A3.

d) If both policies were compared, the price ceiling would have the society better off. This is due
to fact that whenever a tax is imposed upon a market, there is always deadweight lost. On the
other hand, imposing a price ceiling would increase the welfare of consumers, i.e. those hiring,
and decrease welfare of who supply the labour. This is represented in Appendix A4a and A4b.

e) Supposing the labour market in the US are open to international trade, this suggests that the
supply of labour in the US will increase as more foreign banking sector executives look for
work as they are unemployed. This then shifts the supply curve to the right, as shown in
Appendix A5, and the previous shortage of labour may be reduced or even eliminated from
the market depending on how much the quantity supplied increases by.
Question 2

The Australian tobacco industry has been imposed an excise since federation in 1901. It is a
market which heavily involves the Australian government for many reasons, such as raising revenue
from taxing tobacco, and is considered an oligopoly with few sellers, and is relatively difficult to enter
and leave the market.

An economic problem associated with the market is the rate at which the price of tobacco
increases. This is mainly due to the increasing size of excise placed on tobacco, which increases by a
rate of 12.5% year on year, effectively increasing the price of purchasing tobacco by 12.5% year on
year. In theory, should there be no government intervention and the market was perfectly competitive,
the price would settle at the point where the demand curve meets the supply curve at the equilibrium
point. At this point, the increase to price over each year would be due to the rate of inflation, which
currently has a CPI of 1.5; being significantly lower than the 12.5% increase year on year.

However, the key assumption here is that there are no other externalities which affect the net
social benefits, whether it be positive or negative. Thus, it is assumed that in this instance net social
benefits is equal to net private benefits. So, if private marginal benefits is assumed to be constant and
is the private marginal costs, i.e. price of purchasing tobacco is reduced, the net private benefits is
maximised, and in turn net social benefits. By this assumption, any government intervention in the
form of a tax or excise, as anything imposed upon the producer is then passed onto the consumer,
may cause an inefficient allocation of resources; producers having decreased technical efficiency due
to an increased amount of input required for the same output, and consumers pay more for the same
amount.

Despite the assumption of no externalities, this is not the case in the real world. One possible
form of market failure is the existence of negative externalities such as pollution and health hazards.
The inhalation of the smoke, a by-product of consuming tobacco, causes health issues not only for the
consumer, but also the people around whom the consumer consumes their tobacco. If any are to be
admitted to a hospital, the costs relating to their treatment are shouldered by the rest of society who
pay their taxes, thus decreasing the net social benefits due to the increase in social marginal costs.
Furthermore, said by-product also contributes to pollution in the form of increased carbon based
emissions. This is not only shouldered by the people, but also the entire ecosystem as weather and air
quality may be directly affected.

The government has two options to correct the market failure; either outright ban tobacco or
impose an excise on it. An outright ban on tobacco is not a feasible option as tobacco attracts GST,
thus any sale of tobacco will generate government revenue. As stated before, an excise has existed
since 1901 and is the better choice. By taxing tobacco, it is likely to achieve two effects. The first is the
revenue earned from the tax can be used to offset any negative externalities through increased
funding in health and the environment. The second is, there is likely to be reduced marginal social cost
in lieu of the increasing price of tobacco due to the excise. Both effects are expected to increase the
net social benefits of consuming tobacco.
Appendix A

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