Monday, April 16, 2012

What else will also change?

Principle

When assessing a policy change, also take indirect impacts into account.

Tip

A good way to identify indirect impacts is to consider all agents and ask yourself how the policy change may affect their decisions. Then examine how these changes in their decisions may have further impacts, and so on.

Example

The tax rates on labor income are reduced. What kind of impacts may this policy change have?

A direct impact is that, thanks to that reform, workers will have more money after paying their taxes. Being richer may have an impact on how much workers want to work. Moreover, the fact that they will keep more of the money they will earn from working more may also have a direct impact on how much they want to work. How much workers want to work may have an impact on wages, etc.

To discuss all these links in more detail, you need to have some idea about i) how workers decide how much they work (insofar as they can choose), ii) how wages are set, etc.

Exercise

A regulation is introduced to prohibit rents from being higher than some limit (price controls). What kind of impacts may this policy change have?