Chapter 6: Supply, Demand, and Government Policies Ch. 6: Supply, Demand, and Government Policies
Chapter 6: Supply, Demand, and Government Policies
Government policies that alter the private market outcome Price controls: Price ceiling: a legal maximum on the price of a good or service. (Rent control in New York City) Price floor: a legal minimum on the price of a good or service. (State and federal minimum wages)
Chapter 6: Supply, Demand, and Government Policies
Government policies that alter the private market outcome Taxes: The government can make buyers or sellers pay a specific amount on each unit. The effect of price controls and taxes can be shown using our supply and demand framework. How much do cigarettes really cost?
Chapter 6: Supply, Demand, and Government Policies Supply and demand for pizza in Laramie. Price of a large pizza
Market supply and demand for pizza in Laramie
$24 Supply curve
Demand curve $20
$16 Equilibrium price $12
$4
0
0
35
70
105
Equilibrium Quantity of Pizzas
140
175
210
Quantity of movies
Chapter 6: Supply, Demand, and Government Policies A binding price ceiling, $8, on pizza in Laramie. Price of a large pizza
Market supply and demand for pizza in Laramie
$24 Supply curve
Demand curve $20
$16 Equilibrium price $12
Price ceiling $8
Shortage: quantity demanded exceeds quantity supplied.
$4
0
0
35
70 105 140 Equilibrium Quantity Quantity supplied Quantity of Pizzas demanded
175
210
Quantity of movies
Chapter 6: Supply, Demand, and Government Policies A non-binding price ceiling on pizza in Laramie. Price of a large pizza
Market supply and demand for pizza in Laramie: Laramie municipality imposes a price ceiling of $16 on pizza, what happens to equilibrium?
$24
Supply curve
Demand curve $20 Price ceiling$16 Equilibrium price $12
$8
$4
0
0
35
70
105
Equilibrium Quantity of Pizzas
140
175
210
Quantity of movies
Chapter 6: Supply, Demand, and Government Policies A non-binding price ceiling on pizza in Laramie. Price of a large pizza
Market supply and demand for pizza in Laramie: Laramie municipality imposes a price ceiling of $16 on pizza, what happens to equilibrium?
$24
Supply curve
Demand curve $20
Nothing! No distortion occurs in equilibrium because the price ceiling is not binding.
Price ceiling$16 Equilibrium price $12
$8
$4
0
0
35
70
105
Equilibrium Quantity of Pizzas
140
175
210
Quantity of movies
Chapter 6: Supply, Demand, and Government Policies Supply and demand for Moscow mules in Laramie. Price of a Moscow mule
Market supply and demand for Moscow mules in Laramie $6 Supply curve
Demand curve $5
$4 Equilibrium price $3
$2
$1
0
0
100
200
300 400 Equilibrium Quantity of Moscow mules
500
600
Quantity of Moscow mules
Chapter 6: Supply, Demand, and Government Policies A binding price floor on Moscow mules in Laramie. Price of a Moscow mule $6
Market supply and demand for Moscow mules in Laramie: UW students are getting too wild and crazy, so Laramie municipality puts a price floor of $5 on Moscow mules, what happens to equilibrium? Supply curve Demand curve
$5
$4 Equilibrium price $3
$2
$1
0
0
100
200
300 400 Equilibrium Quantity of Moscow mules
500
600
Quantity of Moscow mules
Chapter 6: Supply, Demand, and Government Policies A binding price floor on Moscow mules in Laramie. Price of a Moscow mule $6
Market supply and demand for Moscow mules in Laramie: UW students are getting too wild and crazy, so Laramie municipality puts a price floor of $5 on Moscow mules, what happens to equilibrium? Supply curve Demand curve
Price floor $5
Surplus: quantity supplied exceeds quantity demanded.
$4 Equilibrium price $3
$2
$1
0
0
100 Quantity demanded
200
300 400 Equilibrium Quantity of Moscow mules
500 Quantity supplied
600
Quantity of Moscow mules
Chapter 6: Supply, Demand, and Government Policies A non-binding price floor on Moscow mules in Laramie. Price of a Moscow mule $6
Market supply and demand for Moscow mules in Laramie: What happens to equilibrium if the price floor is placed at $2? Supply curve
Demand curve
$5
$4 Equilibrium price $3
Price floor $2
$1
0
0
100
200
300 400 Equilibrium Quantity of Moscow mules
500
600
Quantity of Moscow mules
Chapter 6: Supply, Demand, and Government Policies A non-binding price floor on Moscow mules in Laramie. Price of a Moscow mule $6
Market supply and demand for Moscow mules in Laramie: What happens to equilibrium if the price floor is placed at $2? Supply curve
Demand curve
$5 Nothing! No distortion occurs in equilibrium because the price ceiling is not binding.
$4 Equilibrium price $3
Price floor $2
$1
0
0
100
200
300 400 Equilibrium Quantity of Moscow mules
500
600
Quantity of Moscow mules
Chapter 6: Supply, Demand, and Government Policies Price controls only cause market distortions if they are binding. A price ceiling is binding if it is set below the market price, while a price floor is binding if it is set above the market price. Price controls can cause distortions because the price may not not ensure that the consumer with the highest valuation of an item will necessarily receive that item. How much are you willing to pay for a 1 pound Rib eye steak?
Chapter 6: Supply, Demand, and Government Policies How do price controls (price floors and price ceilings) affect the market for labor? Market supply and demand for labor Wage / hour $12 Demand for labor
Supply for labor
$10 $8
$6
Equilibrium without price controls 900 workers are employed and earn $6 per hour
$4
$2
0
0
300
600
900 1200 Quantity of workers
1500
1800
Chapter 6: Supply, Demand, and Government Policies How do price controls (price floors and price ceilings) affect the market for labor? Market supply and demand for labor Wage / hour $12 Demand for labor
Supply of labor A “minimum wage” serves as a price floor in the market for labor.
Min. wage $10 $8
$6
Equilibrium without price controls
At a price of $10/hour, 1500 workers are willing to supply their labor but only 300 jobs are available at that price.
$4 What is unemployment? $2
0
0
300
600
900 1200 Quantity of workers
1500
1800
Chapter 6: Supply, Demand, and Government Policies How do price controls (price floors and price ceilings) affect the market for labor? Market supply and demand for labor Wage / hour 1200 unemployed workers
$12 Demand for labor
Supply of labor
unemployment
Min. wage $10
A “minimum wage” serves as a price floor in the market for labor.
$8
$6
Equilibrium without price controls
At a price of $10/hour, 1500 workers are willing to supply their labor but only 300 jobs are available at that price.
$4 What is unemployment?
$2
0
0
300
600
900 1200 Quantity of workers
1500
1800
Chapter 6: Supply, Demand, and Government Policies Governments must provide public goods such as national defense and schools that markets do not provide (or under provide) and must generate revenue to pay for them... taxes can generate this revenue.
Chapter 6: Supply, Demand, and Government Policies A tax may come in the form of a per-unit fee for all goods or services purchased... what happens if the buyer must incur this tax? Price of cigarettes $12
A tax on cigarettes in the United States: Taxing the buyer of cigarettes
Demand
Supply
$9
$6 $1 tax on buyers
Buyers were paying $6 for cigarettes and demanded 1000 packs.
$5
0
0
500
1000 Quantity of cigarettes demanded
2000
Chapter 6: Supply, Demand, and Government Policies A tax may come in the form of a per-unit fee for all goods or services purchased... what happens if the buyer must incur this tax? New Demand
Price of cigarettes $12
Demand
A tax on cigarettes in the United States: Taxing the buyer of cigarettes
Supply
$9
$6 $1 tax on buyers
They now pay an additional $1 per pack… the market price would have to be $5 for them to still demand 1000 packs… their demand curve shifts left.
$5
0
Buyers were paying $6 for cigarettes and demanded 1000 packs.
0
500
1000 Quantity of cigarettes demanded
2000
Chapter 6: Supply, Demand, and Government Policies A tax may come in the form of a per-unit fee for all goods or services purchased... what happens if the buyer must incur this tax? New Demand
Price of cigarettes $12
Demand
A tax on cigarettes in the United States: Taxing the buyer of cigarettes
Supply
$9
$6 $1 tax on buyers
$5.50 $5
Once demand adjusts, the new equilibrium price is $5.50.. Buyers pay $6.50 after the tax ($.50 more than before the tax) and suppliers receive $5.50 after the tax ($.50 less than before the tax)! Buyers and sellers share the burden of the tax!
0
0
500
1000 Quantity of cigarettes demanded
2000
Chapter 6: Supply, Demand, and Government Policies A tax may come in the form of a per-unit fee for all goods or services purchased... what happens if the seller must incur this tax? Price of cigarettes $12
A tax on cigarettes in the United States: Taxing the seller of cigarettes
Demand
Supply
$1 tax on sellers
$7
$6 Sellers were receiving $6 for cigarettes and supplied 1000 packs. $5
0
0
500
1000 Quantity of cigarettes demanded
2000
Chapter 6: Supply, Demand, and Government Policies A tax may come in the form of a per-unit fee for all goods or services purchased... what happens if the seller must incur this tax? Price of cigarettes $12
A tax on cigarettes in the United States: Taxing the seller of cigarettes
Demand
New Supply Supply
$7
$6
$1 tax on sellers
They now receive $1 less per pack… the market price would have to be $7 for them to still supply 1000 packs… their supply curve shifts left.
$5
0
Sellers were receiving $6 for cigarettes and supplied 1000 packs.
0
500
1000 Quantity of cigarettes demanded
2000
Chapter 6: Supply, Demand, and Government Policies A tax may come in the form of a per-unit fee for all goods or services purchased... what happens if the seller must incur this tax? Price of cigarettes $12
A tax on cigarettes in the United States: Taxing the seller of cigarettes
Demand
New Supply Supply
$7 $6.50 $6
$1 tax on sellers
$5
Once demand adjusts, the new equilibrium price is $5.50.. Buyers pay $6.50 after the tax ($.50 more than before the tax) and suppliers receive $5.50 after the tax ($.50 less than before the tax)! Buyers and sellers share the burden of the tax!
0
0
500
1000 Quantity of cigarettes demanded
2000
Chapter 6: Supply, Demand, and Government Policies
Regardless of who the government taxes, the buyers and sellers will share the burden of that tax! Why? • Taxing the buyers causes their demand curve to adjust (shift
left) to a point that splits the tax. • Taxing the suppliers causes their supply curve to adjust (shift
left) to a point that splits the tax.