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    • 1. 6 Supply, Demand, and Government Policies
    • 2. Supply, Demand, and Government Policies <ul><li>In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. </li></ul><ul><li>While equilibrium conditions may be efficient, it may be true that not everyone is satisfied. </li></ul><ul><li>One of the roles of economists is to use their theories to assist in the development of policies. </li></ul>
    • 3. CONTROLS ON PRICES <ul><li>Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. </li></ul><ul><li>Result in government-created price ceilings and floors. </li></ul>
    • 4. CONTROLS ON PRICES <ul><li>Price Ceiling </li></ul><ul><ul><li>A legal maximum on the price at which a good can be sold. </li></ul></ul><ul><li>Price Floor </li></ul><ul><ul><li>A legal minimum on the price at which a good can be sold. </li></ul></ul>
    • 5. How Price Ceilings Affect Market Outcomes <ul><li>Two outcomes are possible when the government imposes a price ceiling: </li></ul><ul><ul><li>The price ceiling is not binding if set above the equilibrium price. </li></ul></ul><ul><ul><li>The price ceiling is binding if set below the equilibrium price, leading to a shortage. </li></ul></ul>
    • 6. Figure 1 A Market with a Price Ceiling (a) A Price Ceiling That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity $4 Price ceiling Equilibrium price Demand Supply 3 100
    • 7. Figure 1 A Market with a Price Ceiling Copyright©2003 Southwestern/Thomson Learning (b) A Price Ceiling That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply 2 Price ceiling Shortage 75 Quantity supplied 125 Quantity demanded Equilibrium price $3
    • 8. How Price Ceilings Affect Market Outcomes <ul><li>Effects of Price Ceilings </li></ul><ul><li>A binding price ceiling creates </li></ul><ul><ul><li>shortages because Q D > Q S . </li></ul></ul><ul><ul><ul><li>Example: Gasoline shortage of the 1970s </li></ul></ul></ul><ul><ul><li>nonprice rationing </li></ul></ul><ul><ul><ul><li>Examples: Long lines, discrimination by sellers </li></ul></ul></ul>
    • 9. <ul><li>In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline. </li></ul><ul><li>What was responsible for the long gas lines? </li></ul>CASE STUDY: Lines at the Gas Pump <ul><li>Economists blame government regulations that limited the price oil companies could charge for gasoline. </li></ul>
    • 10. Figure 2 The Market for Gasoline with a Price Ceiling Copyright©2003 Southwestern/Thomson Learning (a) The Price Ceiling on Gasoline Is Not Binding Quantity of Gasoline 0 Price of Gasoline 1. Initially, the price ceiling is not binding . . . Price ceiling Demand Supply, S 1 P 1 Q 1
    • 11. Figure 2 The Market for Gasoline with a Price Ceiling Copyright©2003 Southwestern/Thomson Learning (b) The Price Ceiling on Gasoline Is Binding Quantity of Gasoline 0 Price of Gasoline Demand S 1 S 2 Price ceiling Q S 4. . . . resulting in a shortage. 3. . . . the price ceiling becomes binding . . . 2. . . . but when supply falls . . . P 2 Q D P 1 Q 1
    • 12. CASE STUDY: Rent Control in the Short Run and Long Run <ul><li>Rent controls are ceilings placed on the rents that landlords may charge their tenants. </li></ul><ul><li>The goal of rent control policy is to help the poor by making housing more affordable. </li></ul><ul><li>One economist called rent control “the best way to destroy a city, other than bombing.” </li></ul>
    • 13. Figure 3 Rent Control in the Short Run and in the Long Run Copyright©2003 Southwestern/Thomson Learning (a) Rent Control in the Short Run (supply and demand are inelastic) Quantity of Apartments 0 Rental Price of Apartment Supply Controlled rent Demand Shortage
    • 14. Figure 3 Rent Control in the Short Run and in the Long Run Copyright©2003 Southwestern/Thomson Learning (b) Rent Control in the Long Run (supply and demand are elastic) 0 Rental Price of Apartment Quantity of Apartments Demand Supply Controlled rent Shortage
    • 15. How Price Floors Affect Market Outcomes <ul><li>When the government imposes a price floor, two outcomes are possible. </li></ul><ul><li>The price floor is not binding if set below the equilibrium price. </li></ul><ul><li>The price floor is binding if set above the equilibrium price, leading to a surplus. </li></ul>
    • 16. Figure 4 A Market with a Price Floor Copyright©2003 Southwestern/Thomson Learning (a) A Price Floor That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity 2 Price floor Equilibrium price Demand Supply $3 100
    • 17. Figure 4 A Market with a Price Floor Copyright©2003 Southwestern/Thomson Learning (b) A Price Floor That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply $4 Price floor 80 Quantity demanded 120 Quantity supplied Equilibrium price Surplus 3
    • 18. How Price Floors Affect Market Outcomes <ul><li>A price floor prevents supply and demand from moving toward the equilibrium price and quantity. </li></ul><ul><li>When the market price hits the floor, it can fall no further, and the market price equals the floor price. </li></ul>
    • 19. How Price Floors Affect Market Outcomes <ul><li>A binding price floor causes . . . </li></ul><ul><ul><li>a surplus because Q S > Q D . </li></ul></ul><ul><ul><li>nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. </li></ul></ul><ul><ul><ul><li>Examples: The minimum wage, agricultural price supports </li></ul></ul></ul>
    • 20. The Minimum Wage <ul><li>An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay. </li></ul>
    • 21. Figure 5 How the Minimum Wage Affects the Labor Market Copyright©2003 Southwestern/Thomson Learning Quantity of Labor Wage 0 Labor demand Labor Supply Equilibrium employment Equilibrium wage
    • 22. Figure 5 How the Minimum Wage Affects the Labor Market Copyright©2003 Southwestern/Thomson Learning Quantity of Labor Wage 0 Labor Supply Labor surplus (unemployment) Labor demand Minimum wage Quantity demanded Quantity supplied
    • 23. TAXES <ul><li>Governments levy taxes to raise revenue for public projects. </li></ul>
    • 24. How Taxes on Buyers (and Sellers) Affect Market Outcomes <ul><li>Taxes discourage market activity. </li></ul><ul><li>When a good is taxed, the quantity sold is smaller. </li></ul><ul><li>Buyers and sellers share the tax burden. </li></ul>
    • 25. Elasticity and Tax Incidence <ul><li>Tax incidence is the manner in which the burden of a tax is shared among participants in a market. </li></ul>
    • 26. Elasticity and Tax Incidence <ul><li>Tax incidence is the study of who bears the burden of a tax. </li></ul><ul><li>Taxes result in a change in market equilibrium. </li></ul><ul><li>Buyers pay more and sellers receive less, regardless of whom the tax is levied on. </li></ul>
    • 27. Figure 6 A Tax on Buyers Copyright©2003 Southwestern/Thomson Learning Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium without tax Tax ($0.50) Price buyers pay D 1 D 2 Supply, S 1 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). $3.30 90 Equilibrium with tax 2.80 3.00 100
    • 28. Elasticity and Tax Incidence <ul><li>What was the impact of tax? </li></ul><ul><ul><li>Taxes discourage market activity. </li></ul></ul><ul><ul><li>When a good is taxed, the quantity sold is smaller. </li></ul></ul><ul><ul><li>Buyers and sellers share the tax burden. </li></ul></ul>
    • 29. Figure 7 A Tax on Sellers Copyright©2003 Southwestern/Thomson Learning Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 2.80 Price without tax Price sellers receive Equilibrium with tax Equilibrium without tax Tax ($0.50) Price buyers pay S 1 S 2 Demand, D 1 A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). 3.00 100 $3.30 90
    • 30. Figure 8 A Payroll Tax Copyright©2003 Southwestern/Thomson Learning Quantity of Labor 0 Wage Labor demand Labor supply Tax wedge Wage workers receive Wage firms pay Wage without tax
    • 31. Elasticity and Tax Incidence <ul><li>In what proportions is the burden of the tax divided? </li></ul><ul><li>How do the effects of taxes on sellers compare to those levied on buyers? </li></ul><ul><li>The answers to these questions depend on the elasticity of demand and the elasticity of supply. </li></ul>
    • 32. Figure 9 How the Burden of a Tax Is Divided Copyright©2003 Southwestern/Thomson Learning Quantity 0 Price (a) Elastic Supply, Inelastic Demand Demand Supply Tax Price sellers receive Price buyers pay 2. . . . the incidence of the tax falls more heavily on consumers . . . 1. When supply is more elastic than demand . . . Price without tax 3. . . . than on producers.
    • 33. Figure 9 How the Burden of a Tax Is Divided Copyright©2003 Southwestern/Thomson Learning Quantity 0 Price (b) Inelastic Supply, Elastic Demand Demand Supply Tax Price sellers receive Price buyers pay 3. . . . than on consumers. 1. When demand is more elastic than supply . . . Price without tax 2. . . . the incidence of the tax falls more heavily on producers . . .
    • 34. <ul><li>So, how is the burden of the tax divided? </li></ul><ul><li>The burden of a tax falls more heavily on the side of the market that is less elastic. </li></ul>ELASTICITY AND TAX INCIDENCE
    • 35. Summary <ul><li>Price controls include price ceilings and price floors. </li></ul><ul><li>A price ceiling is a legal maximum on the price of a good or service. An example is rent control. </li></ul><ul><li>A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage. </li></ul>
    • 36. Summary <ul><li>Taxes are used to raise revenue for public purposes. </li></ul><ul><li>When the government levies a tax on a good, the equilibrium quantity of the good falls. </li></ul><ul><li>A tax on a good places a wedge between the price paid by buyers and the price received by sellers. </li></ul>
    • 37. Summary <ul><li>The incidence of a tax refers to who bears the burden of a tax. </li></ul><ul><li>The incidence of a tax does not depend on whether the tax is levied on buyers or sellers. </li></ul><ul><li>The incidence of the tax depends on the price elasticities of supply and demand. </li></ul><ul><li>The burden tends to fall on the side of the market that is less elastic. </li></ul>

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