6
Supply, Demand, and Government Policies
In this chapter, look for the answers to these questions:
What are price ceilings and price floors? What are some examples of each?
PRINCIPLES OF
How do price ceilings and price floors affect
MICROECONOMICS
market outcomes?
FOURTH EDITION
How do taxes affect market outcomes? How does the outcome depend on whether the tax is imposed on buyers or sellers?
N. G R E G O R Y M A N K I W
What is the incidence of a tax?
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What determines the incidence? CHAPTER 6
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Government Policies That Alter the Private Market Outcome
EXAMPLE 1: The Market for Apartments
Price controls
• •
P
Rental price of apts
Price ceiling: a legal maximum on the price of a good or service. Example: rent control. Price floor: a legal minimum on the price of a good or service. Example: minimum wage.
S
$800
Eq’m Eq’m w/o w/o price price controls controls
Taxes
•
1
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The govt can make buyers or sellers pay a specific amount on each unit bought/sold.
D
We We will will use use the the supply/demand supply/demand model model to to see see how how each each policy policy affects affects the the market market outcome outcome (the (the price price buyers buyers pay, pay, the the price price sellers sellers receive, receive, and eq’ ’m quantity). eq and eq’m quantity). CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
300
Quantity of apartments 2
How Price Ceilings Affect Market Outcomes A price ceiling above the eq’m price is not binding – has no effect on the market outcome.
P
Price ceiling
$800
D 300
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
How Price Ceilings Affect Market Outcomes
The ceiling is a binding constraint on the price, causes a shortage.
Q
4
3
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The eq’m price ($800) is above the ceiling and therefore illegal.
S
$1000
Q
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P
S
$800 Price ceiling
$500 shortage D 250
400
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
5
1
Shortages and Rationing
How Price Ceilings Affect Market Outcomes In the long run, supply and demand are more price-elastic.
With a shortage, sellers must ration the goods
P
S
Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases
$800
These mechanisms are often unfair, and inefficient: Price ceiling
$500
So, the shortage is larger.
shortage
the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair). 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
EXAMPLE 2: The Market for Unskilled Labor Wage paid to unskilled workers
W
CHAPTER 6
$4
D 500
7
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes A price floor below the eq’m price is not binding – has no effect on the market outcome.
S
Eq’m Eq’m w/o w/o price price controls controls
the goods do not necessarily go to the buyers who value them most highly.
In contrast, when prices are not controlled,
D Q
450
150
CHAPTER 6
among buyers.
W
S
$4 Price floor
$3 D
L
500
L
Quantity of unskilled workers CHAPTER 6
8
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
How Price Floors Affect Market Outcomes The eq’m wage ($4) is below the floor and therefore illegal. The floor is a binding constraint on the wage, causes a surplus (i.e., unemployment). CHAPTER 6
W
labor surplus S
The Minimum Wage Min wage laws do not affect highly skilled workers.
Price floor
$5 $4
They do affect teen workers.
D 400
550
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Studies: A 10% increase in the min wage raises teen unemployment by 1-3%.
L
10
9
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
W
unemployment S
Min. wage
$5 $4
D 400
550
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
L
11
2
ACTIVE LEARNING
Price floors & ceilings
1:
ACTIVE LEARNING
The market for hotel rooms
P 140 130
Determine effects of:
S
120 110
A. $90 price ceiling
100
B. $90 price floor
80
C. $120 price floor
A. $90 price ceiling
90
D
70 60 50
1: The market for hotel rooms
P 140
The price falls to $90. Buyers demand 120 rooms, sellers supply 90, leaving a shortage.
40 0 Q 50 60 70 80 90 100 110 120 130
S
130 120 110 100 90
Price ceiling
D
80
shortage = 30
70 60 50
40 0 Q 50 60 70 80 90 100 110 120 130
12
ACTIVE LEARNING
B. $90 price floor
1:
Eq’m price is above the floor, so floor is not binding.
130
P = $100, Q = 100 rooms.
90
ACTIVE LEARNING
The market for hotel rooms
P 140
C. $120 price floor S
120 110 100 80
13
Price floor
D
70 60
1:
P 140
The price rises to $120.
130
Buyers demand 60 rooms, sellers supply 120, causing a surplus.
110
120
The market for hotel rooms surplus = 60
S
Price floor
100 90 80
D
70 60
50
50
40 0 Q 50 60 70 80 90 100 110 120 130
40 0 Q 50 60 70 80 90 100 110 120 130
14
15
Evaluating Price Controls
Taxes The govt levies taxes on many goods & services
Recall one of the Ten Principles:
to raise revenue to pay for national defense, public schools, etc.
Markets are usually a good way to organize economic activity.
Prices are the signals that guide the allocation of
The govt can make buyers or sellers pay the tax.
society’s resources. This allocation is altered when policymakers restrict prices.
The tax can be a % of the good’s price, or a specific amount for each unit sold. • For simplicity, we analyze per-unit taxes only.
Price controls often intended to help the poor, but often hurt more than help.
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
16
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
17
3
A Tax on Buyers
EXAMPLE 3: The Market for Pizza
Eq’m Eq’m w/o w/o tax tax
A A tax tax on on buyers buyers shifts shifts the the D D curve curve down down by by the the amount amount of of the the tax. tax.
P S1 $10.00
D1 Q
500 CHAPTER 6
18
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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P S1 Tax
$10.00 PS = $9.50 D1 Q
430 500
20
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The Outcome Is the Same in Both Cases! The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers! P What matters is this: PB = $11.00 A tax drives $10.00 a wedge PS = $9.50 between the price buyers pay and the price sellers receive. CHAPTER 6
Tax
$10.00 PS = $9.50 D1 D2
Q
430 500
19
A Tax on Sellers
D2
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S1
PB = $11.00
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A A tax tax on on sellers sellers shifts shifts the the S S curve curve up up by by the the amount amount of of the the tax. tax.
how the burden of a tax is shared among market participants
PB = $11.00
P
The The price price buyers buyers pay pay rises, rises, the the price price sellers sellers receive receive falls, falls, eq’m eq’m Q Q falls. falls.
The Incidence of a Tax:
Because Because of of the the tax, tax, buyers buyers pay pay $1.00 $1.00 more, more, sellers sellers get get $0.50 $0.50 less. less.
Effects of a $1.50 per unit tax on buyers
S1 Tax
D1
430 500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
Effects of a $1.50 per unit tax on sellers P
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S1
PB = $11.00
The The price price buyers buyers pay pay rises, rises, the the price price sellers sellers receive receive falls, falls, eq’m eq’m Q Q falls. falls.
S2 Tax
$10.00 PS = $9.50 D1
430 500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
ACTIVE LEARNING
Effects of a tax
P 140
Suppose govt imposes a tax on buyers of $30 per room.
130
Find new Q, PB, PS, and incidence of tax.
90
Q
21
2: The market for hotel rooms
S
120 110 100 80
D
70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130
22
23
4
ACTIVE LEARNING
Answers
P 140
2: The market for hotel rooms
130
Q = 80
Elasticity and Tax Incidence S
CASE 1: Supply is more elastic than demand
PB = 110 100
PB = $110
90
PS = $80
Buyers’ share of tax burden
Tax
D
PS = 80
70
Incidence buyers: $10 sellers: $20
Tax
Price if no tax PS
50
D
PB
Price if no tax
Tax PS
Sellers Sellers bear bear most most of of the the burden burden of of the the tax. tax.
D
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
25
1990: Congress adopted a luxury tax on yachts,
It’s It’s easier easier for for buyers buyers than than sellers sellers to to leave leave the the market. market.
S
CHAPTER 6
CASE STUDY: Who Pays the Luxury Tax?
CASE 2: Demand is more elastic than supply P
So So buyers buyers bear bear most most of of the the burden burden of of the the tax. tax. Q
40 0 Q 50 60 70 80 90 100 110 120 130
Elasticity and Tax Incidence
Sellers’ share of tax burden
PB
Sellers’ share of tax burden
60
24
Buyers’ share of tax burden
It’s It’s easier easier for for sellers sellers than than S buyers buyers to to leave leave the the market. market.
P
120
private airplanes, furs, expensive cars, etc.
Goal of the tax: to raise revenue from those who could most easily afford to pay – wealthy consumers.
But who really pays this tax?
Q CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
26
P
Buyers’ share of tax burden
Sellers’ share of tax burden
PS
D Q
CHAPTER 6
allocation of society’s resources.
In In the the short short run, run, supply supply is is inelastic. inelastic. Tax
Hence, Hence, companies companies that that build build yachts yachts pay pay most most of of the the tax. tax.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
27
the Allocation of Resources Each of the policies in this chapter affects the
Demand Demand is is price-elastic. price-elastic. S
PB
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CONCLUSION: Government Policies and
CASE STUDY: Who Pays the Luxury Tax? The market for yachts
CHAPTER 6
28
• Example 1:
a tax on pizza reduces eq’m Q. With less production of pizza, resources (workers, ovens, cheese) will become available to other industries.
• Example 2:
a binding minimum wage causes a surplus of workers, a waste of resources.
So, it’s important for policymakers to apply such policies very carefully. CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
29
5
CHAPTER SUMMARY
CHAPTER SUMMARY A tax on a good places a wedge between the
A price ceiling is a legal maximum on the price of
price buyers pay and the price sellers receive, and causes the eq’m quantity to fall, whether the tax is imposed on buyers or sellers.
a good. An example is rent control. If the price ceiling is below the eq’m price, it is binding and causes a shortage.
A price floor is a legal minimum on the price of a
The incidence of a tax is the division of the
good. An example is the minimum wage. If the price floor is above the eq’m price, it is binding and causes a surplus. The labor surplus caused by the minimum wage is unemployment.
burden of the tax between buyers and sellers, and does not depend on whether the tax is imposed on buyers or sellers.
The incidence of the tax depends on the price elasticities of supply and demand.
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
30
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31
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