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    Chapter 6 Chapter 6 Presentation Transcript

    • Chapter 6 What are price ceilings and price floors? What are some examples of each? How do price ceilings and price floors affect market outcomes? How do taxes affect market outcomes? How does the outcome depend on whether the tax is imposed on buyers or sellers? What is the incidence (rate/range of influence/occurrence) of a tax? What determines the incidence?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. Example: rent control. – Price Floor: a legal minimum on the price of a good or service. Example: minimum wage. Taxes – The Government can make buyers or sellers pay a specific amount on each unit bought/sold.SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • EXAMPLE 1: The Market for Apartments Rental P S price of apartments $800 Equilibrium without price D Q controls 300 Quantity of apartmentsSUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • How Price Ceilings Affect Market Outcomes P S Price $1000 A price ceiling Ceiling $800 above the equilibrium price is not binding – has no effect D Q on the market 300 outcome. SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • How Price Ceilings Affect Market Outcomes P The equilibrium S price ($800) is above the ceiling and $800 therefore illegal. Price The ceiling $500 Ceiling is a binding Shortage constraint D on the price, Q 250 400 causes a shortage. SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • How Price Ceilings Affect Market Outcomes P S In the long run, supply and demand $800 are more price-elastic. $500 Price Therefore, the Ceiling Shortage shortage D will be larger. Q 150 450 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • Shortages and Rationing With a shortage, sellers must ration the goods among buyers. Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases These mechanisms are often unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly. In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair).SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • EXAMPLE 2: The Market for Unskilled Labor Wage W S paid to unskilled workers $4 Equilibrium without D price L controls 500 Quantity of unskilled workersSUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • How Price Floors Affect Market Outcomes W S A price floor below the equilibrium price is $4 not binding – Price $3 has no effect floor on the market D outcome. L 500SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • How Price Floors Affect Market Outcomes LaborThe equilibrium W Surplus Swage ($4) is below Price $5the floor and Floortherefore illegal. $4The floor is abinding constrainton the wage,causes a surplus D(i.e.,unemployment). L 400 550SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • The Minimum Wage Unemployment W S MinimumMinimum wage $5 Wagelaws do not affecthighly skilled $4workers.Often, they affectteen workers. D L 400 550SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • Price Floors & Ceilings The market for P 140 hotel roomsDetermine S 130effects of: 120 A. $90 price 110 ceiling 100 B. $90 price floor 90 80 D C. $120 price floor 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • A. $90 Price Ceiling The market for P 140 hotel rooms S The price 130 falls to $90. 120 110 Buyers 100 demand Price ceiling 90 120 rooms, 80 D sellers supply shortage = 30 70 90, leaving a 60 shortage. 50 40 0 Q 50 60 70 80 90 100 110 120 130SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • B. $90 Price Floor The market for P 140 hotel rooms S 130 Equilibrium price is above 120 the floor, so the 110 floor is not 100 binding. 90 Price floor P = $100, 80 D Q = 100 rooms. 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • C. $120 price floor The market for P 140 hotel rooms surplus = 60 S 130 The price 120 rises to $120. Price floor 110 Buyers 100 demand 60 rooms, 90 sellers supply 80 D 120, causing a 70 surplus. 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • Evaluating Price Controls Recall one of the Ten Principles of Economics: Markets are usually a good way to organize economic activity. Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices. Price controls often intended to help the poor, but often hurt more than help.SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • Taxes  The Government levies taxes on many goods & services to raise revenue to pay for national defense, public schools, etc.  The Government can make buyers or sellers pay the tax.  The tax can be a % of a good’s price, or a specific amount for each unit sold. – For simplicity, we will analyze per-unit taxes only.SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • EXAMPLE 3: The Market for PizzaEquilibrium P S1without tax $10.00 D1 Q 500SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • A Tax on BuyersA tax onbuyers shifts Effects of a $1.50 perthe D curve unit tax on buyersdown by the Pamount of the S1 PB = $11.00tax. Tax $10.00The price PS = $9.50buyers payrises, the price D1sellers receive D2falls, Q 430 500equilibrium Qfalls. SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • The Incidence of a Tax: How the burden of a tax is shared among market participants P As a result of S1 PB = $11.00 the tax, Tax buyers pay $10.00 $1.00 more, PS = $9.50 and sellers receive D1 $0.50 less. D2 Q 430 500 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • A Tax on SellersA tax on Effects of a $1.50 persellers shifts unit tax on sellersthe S curve up P S2by the amount S1of the tax. PB = $11.00 Tax $10.00 PS = $9.50The price buyerspay rises, theprice sellers D1receive falls,equilibrium Q Q 430 500falls.SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • The Outcome Is the Same in Both Cases!The effects on P and Q, and the tax incidence are thesame whether the tax is imposed on buyers or sellers! PWhat S1matters is PB = $11.00 Taxthis: $10.00A tax drives PS = $9.50a wedge D1between theprice buyers Qpay and the 430 500price sellersreceive. AND GOVERNMENT POLICIESSUPPLY, DEMAND,
    • Effects of a Tax The market for P 140 hotel rooms Suppose the S 130 Government 120 imposes a tax 110 on buyers of 100 $30 per room. 90 Find new Q, PB, PS, 80 D and incidence of 70 tax. 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • A C T I V E L E A R N I N G 2: The market forAnswers P 140 hotel rooms S 130PB = $110 120Q = 80 PB = 110 100 TaxPS = $80 90 PS = 80 D 70 Incidence 60 Buyers: $10 50 Sellers: $20 40 0 Q 50 60 70 80 90 100 110 120 130 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • Elasticity and Tax IncidenceCASE 1: Supply is more elastic than demand P It is easier for sellers than buyers PB S to leave theBuyers’ share market.of tax burden Tax Therefore, buyers Price if no tax bear most of the Sellers’ share burden of the tax. PS of tax burden D QSUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • Elasticity and Tax IncidenceCASE 2: Demand is more elastic than supply It is easier for P buyers than S sellers to leaveBuyers’ share PB the market.of tax burden Sellers bear Price if no tax Tax most of theSellers’ share burden ofof tax burden the tax. PS D QSUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • CASE STUDY: Who Pays the Luxury Tax? 1990: Congress adopted a luxury tax on yachts, 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? SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • CASE STUDY: Who Pays the Luxury Tax? The market for yachts Demand is price-elastic. P S In the short run, Buyers’ share of tax burden PB supply is inelastic. Tax Hence, companies Sellers’ share that build of tax burden PS D yachts pay most of Q the tax. SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • CONCLUSION: Government Policies and the Allocation of Resources Each of the policies in this chapter affects the allocation of society’s resources. – Example 1: A tax on pizza reduces equilibrium 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, and a waste of resources. It is important for policymakers to apply such policies very carefully.SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • CHAPTER SUMMARY  A price ceiling is a legal maximum on the price of a good. An example is rent control. If the price ceiling is below the equilibrium price, it is binding and causes a shortage.  A price floor is a legal minimum on the price of a good. An example is the minimum wage. If the price floor is above the equilibrium price, it is binding and causes a surplus. The labor surplus caused by the minimum wage is unemployment.SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    • CHAPTER SUMMARY A tax on a good places a wedge between the price buyers pay and the price sellers receive, and causes the equilibrium quantity to fall, whether the tax is imposed on buyers or sellers. The incidence of a tax is the division of the 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.SUPPLY, DEMAND, AND GOVERNMENT POLICIES