Economic Erosion

In response to a student's post about how taxes and government regulations reduce the level of economic activity in the private sector.

You are on the right track. If you think of two parties making a deal in a free market (voluntarily) their is a price range within which a deal is possible. The seller usually will not sell below his cost. The buyer will not pay more than the perceived value of the utility that the buyer expects to receive from the purchase.

Imagine that this graph applies to only one seller and one buyer. They will normally agree on a price some place between the intersection of the supply curve and the vertical axis and the demand curve and the vertical axis.

When government introduces additional costs into the picture (tariffs, taxes, regulations, etc.) the price range within which a deal can be made is narrowed. Now the seller must cover his costs of production plus any additional costs imposed by government. The buyer will still not pay an amount greater than the value of the utility he expects from the purchase even though some of that cost goes to government, lawyers, etc.

The result is that the potential price range narrows for many and for a certain number of buyers and sellers it disappears. With every increase in such costs imposed by government, more potential transactions disappear. In this way, regulation and trade barriers reduce the amount of economic activity, since fewer and fewer deals make economic sense to market participants.

		October 29, 2005 *Economic Erosion - How Regulation Shrinks Opportunity*
	In response to a student's post about how taxes and government regulations reduce the level of economic activity in the private sector. You are on the right track. If you think of two parties making a deal in a free market (voluntarily) their is a price range within which a deal is possible. The seller usually will not sell below his cost. The buyer will not pay more than the perceived value of the utility that the buyer expects to receive from the purchase. Imagine that this graph applies to only one seller and one buyer. They will normally agree on a price some place between the intersection of the supply curve and the vertical axis and the demand curve and the vertical axis. When government introduces additional costs into the picture (tariffs, taxes, regulations, etc.) the price range within which a deal can be made is narrowed. Now the seller must cover his costs of production plus any additional costs imposed by government. The buyer will still not pay an amount greater than the value of the utility he expects from the purchase even though some of that cost goes to government, lawyers, etc. The result is that the potential price range narrows for many and for a certain number of buyers and sellers it disappears. With every increase in such costs imposed by government, more potential transactions disappear. In this way, regulation and trade barriers reduce the amount of economic activity, since fewer and fewer deals make economic sense to market participants.