1) What are efficiency, producer surplus, worker surplus, and total gains from t

Question

1) What are efficiency, producer surplus, worker surplus, and total gains from trade?

2) Why would we expect regional wage levels to converge? What happens to total gains from

trade as regional wages converge?

3) How do payroll taxes affect labor markets (i.e., equilibrium employment, wage paid by

employer, wage received by worker, producer surplus, worker surplus, total gains from trade,

incidence of tax)?

4) Does the incidents of tax (who ultimately pays the tax) depend on who the tax is imposed on?

Explain.

5) In what situations would we expect workers to pay most of the payroll tax? Explain using the

concept of elasticity.

Explanation / Answer

1) Efficiency refers to the ideal production level where the total surplus is at maximum. Producer surplus is the area above wage rate and below demand for labor curve. Worker surplus is the area below wage line and above worker supply curve.

2) Regional wage levels will ultimately converge in the long run. Since wage differential will result in labor mobility from one region to other, the wage rate will adjust itself according to mobility. This process will continue till wage rate in both economies become equal.

3) Payroll taxes will reduce the overall surplus. The wage paid by the employee will be higher than equilibrium wage rate. The wage rate received by the employee will be lower than the equilibrium wage rate. With payroll taxes there will be lower level employment, reduced overall surplus.

4) Incidence of tax does not depend on whom the tax is imposed. This depends on the elasticity of each segment. For example if elasticity of demand is greater than elasticity of supply, then tax incidence will be greater on supplier than consumer.

5) Workers will bear burden of tax more if the elasticity of labor supply is lower than elasticity of demand of labor. The greater the elasticity the lower is the incidence of tax and vice versa.

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