Should Airlines Raise Ticket Prices During a Tax Holiday?

Sent to you via Google Reader

Should Airlines Raise Ticket Prices During a Tax Holiday?

One effect of the current stalemate over the debt limit is the expiration of the Federal Aviation Administration’s operating authority, which happened last Saturday. The agency has been partially shut down for a week, and one casualty is its ability to collect airline ticket taxes. Airlines, as predicted, have responded by raising ticket prices by the amount of the tax, leaving the final price unchanged.

Senators Jay Rockefeller (D-WV) and Maria Cantwell (D-WA) are not pleased, and say that airlines should either pass the savings along to consumers or escrow them in an account that “supports federal aviation programs,” which essentially sounds like asking them to pay the tax voluntarily.

There’s no particular reason the price hikes should be controversial. At the risk of stating the obvious, market economies such as our own depend on the abilities of firms to freely set prices, and the economically correct thing during a tax holiday is to raise prices. Let’s review the basic microeconomics of consumption taxes.

The basic effect of a consumption tax on a good is to reduce the supply of that good – in other words, the price is higher at any given quantity, so the supply curve moves to the left. In the charts above, the S1 curve reflects a supply curve assuming no tax, and the S2 curve is the supply curve assuming a consumption tax. The quantity of the good decreases from Q1 to Q2, and the price increases from P1 to P2. In all cases, the size of the gray box reflects the revenue going to the firm; the blue and orange boxes reflect tax revenue going to the government.

In Situation 1, the burden of the tax is shared between consumers and producers. Situation 2 assumes elastic demand – in other words, consumer purchases are very sensitive to price changes. It’s easy to see from the graph that in this situation, the price changes very little, and the firm is unable to pass on the tax to consumers, bearing most of the cost itself. We see the opposite situation in Situation 3, which assumes inelastic demand (in which consumers are not sensitive to price changes.) Here, the price change is significant, and the cost of the tax is borne mainly by consumers.

The fact that most airlines have raised their prices by the amount of the tax suggests that they have determined the market for airline tickets most closely resembles Situation 2, and that demand for airline tickets is elastic. Spirit Airlines did the opposite, and did not raise pric…

Daniel J. SmithSent via mobile phone
Assistant Professor of Economics
Manuel H. Johnson Center for Political Economy
Troy University
Email: smith.dan.j
Website: http://www.danieljosephsmith.com

“The greatest increase in poverty and hardship produced by any law in modern U.S. history.”

Sent to you via Google Reader

“The greatest increase in poverty and hardship produced by any law in modern U.S. history.”

For the
vigilant apocalypse watchers, Robert Greenstein, a budget analyst
at the liberal Center on Budget and Policy Priorities,
is warning that
John Boehner’s proposed debt plan “could well produce
the greatest increase in poverty and hardship produced by
any law in modern U.S. history,” which he apparently believes is
the terrifying likely consequence of cutting government so much
that federal discretionary spending only rises
from $1.034 trillion to $1.234 trillion over the next
decade.

Daniel J. SmithSent via mobile phone
Assistant Professor of Economics
Manuel H. Johnson Center for Political Economy
Troy University
Email: smith.dan.j
Website: http://www.danieljosephsmith.com

Atlanta’s Job-Killing Street Vendor Monopoly

Sent to you via Google Reader

Atlanta’s Job-Killing Street Vendor Monopoly

The Institute for Justice filed a lawsuit yesterday
challenging Atlanta’s grant of an exclusive vending franchise to a
single company, which now enjoys monopoly powers over all street
vending on public property. Among the many losers in this
sweetheart deal are longtime street vendors Larry Miller and
Stanley Hambrick, who have spent years running successful
merchandise stands outside of the Atlanta Braves stadium. Now each
man faces upwards of $20,000 per year in rent if they want to
occupy a state-sanctioned kiosk in the same location. So much for
the city government supporting small businesses and fostering
entrepreneurship.

For more on the case, check out this video produced by the
Institute for Justice:

Daniel J. SmithSent via mobile phone
Assistant Professor of Economics
Manuel H. Johnson Center for Political Economy
Troy University
Email: smith.dan.j
Website: http://www.danieljosephsmith.com

FDA: Moving to a Safety-Only System

Sent to you via Google Reader

FDA: Moving to a Safety-Only System

It now cost about a billion dollars to develop a new drug which means that many potentially beneficial drugs are lost. Economist Michele Boldrin and physician S. Joushua Swamidass explain the problem and suggest a new approach:

Every drug approval requires a massive bet—so massive that only very large companies can afford it. Too many drugs become profitable only when the expected payoff is in the billions….in this high-stakes environment it is difficult to justify developing drugs for rare diseases. They simply do not make enough money to pay for their development….How many potentially good drugs are dropped in silence every year?

Finding treatments for rare disease should concern us all. And as we look closely at genetic signatures of important diseases, we find that each common disease is composed of several rare diseases that only appear the same on the outside.

Nowhere is this truer than with cancer. Every patient’s tumor is genetically unique. That means most cancer patients have in effect a rare disease that may benefit from a drug that works for only a small number of other patients.

…We can reduce the cost of the drug companies’ bet by returning the FDA to its earlier mission of ensuring safety and leaving proof of efficacy for post-approval studies and surveillance.

Harvard Neurologist Peter Lansbury made a similar argument several years ago:

There are also scientific reasons to replace Phase 3. The reasoning behind the Phase 3 requirement — that the average efficacy of a drug is relevant to an individual patient — flies in the face of what we now know about drug responsiveness. Very few drugs are effective in all individuals. In fact, most are not effective in large portions of the population, for reasons that we are just beginning to understand.

It’s much easier to get approval for drugs that are marginally effective in, say, half the population than drugs that are very effective in a small fraction of patients. This statistical barrier discourages the pharmaceutical industry from even beginning to attack diseases, such as Parkinson’s, that are likely to have several subtypes, each of which may respond to a different drug. These drugs are the underappreciated casualties of the Phase 3 requirement; they will never be developed because the risk of failure at Phase 3 is simply too great.

Boldrin and Swamidass offer another suggestion:

In exchange for this simplification, companies would sell medications at a regulated price equal to total economic cost until proven effective, after which the FDA would allow the medications to be sold at market prices. In this way, comp…

Daniel J. SmithSent via mobile phone
Assistant Professor of Economics
Manuel H. Johnson Center for Political Economy
Troy University
Email: smith.dan.j
Website: http://www.danieljosephsmith.com

Recommendations on Income Distribution, Arnold Kling | EconLog | Library of Economics and Liberty

http://econlog.econlib.org/archives/2011/07/recommendations.html

Daniel J. Smith
Sent via mobile phone
Assistant Professor of Economics
Manuel H. Johnson Center for Political Economy
Troy University
Email: smith.dan.j@gmail.com
Website: http://www.danieljosephsmith.com