Supply, Demand, and Government Policies. In this chapter, look for the answers to these questions:

6 Supply, Demand, and Government Policies In this chapter, look for the answers to these questions: ƒ What are price ceilings and price floors? Wha...
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6

Supply, Demand, and Government Policies

In this chapter, look for the answers to these questions:

ƒ What are price ceilings and price floors? What are some examples of each?

PRINCIPLES OF

ƒ How do price ceilings and price floors affect

MICROECONOMICS

market outcomes?

FOURTH EDITION

ƒ 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

ƒ What is the incidence of a tax?

Premium PowerPoint® Slides by Ron Cronovich 2007 update

What determines the incidence? CHAPTER 6

© 2008 Thomson South-Western, all rights reserved

Government Policies That Alter the Private Market Outcome

EXAMPLE 1: The Market for Apartments

ƒ 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

ƒ 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

CHAPTER 6

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

CHAPTER 6

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.

ƒ With a shortage, sellers must ration the goods

P

S

ƒ Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases

$800

ƒ 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.

ƒ 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 ƒ The govt levies taxes on many goods & services

ƒ 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.

ƒ Prices are the signals that guide the allocation of

ƒ The govt can make buyers or sellers pay the tax.

society’s resources. This allocation is altered when policymakers restrict prices.

ƒ 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.

ƒ Price controls often intended to help the poor, but often hurt more than help.

CHAPTER 6

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

16

CHAPTER 6

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

CHAPTER 6

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

CHAPTER 6

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

CHAPTER 6

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

ƒ 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.

ƒ Goal of the tax: to raise revenue from those who could most easily afford to pay – wealthy consumers.

ƒ 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 ƒ 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.

ƒ 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 ƒ A tax on a good places a wedge between the

ƒ 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.

ƒ A price floor is a legal minimum on the price of a

ƒ 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.

ƒ The incidence of the tax depends on the price elasticities of supply and demand.

CHAPTER 6

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

30

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SUPPLY, DEMAND, AND GOVERNMENT POLICIES

31

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