Ch06 Supply Demand And Government Policies
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Ch06 Supply Demand And Government Policies

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Price floors, ceilings, and impact of taxes

Price floors, ceilings, and impact of taxes

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Ch06 Supply Demand And Government Policies Ch06 Supply Demand And Government Policies Presentation Transcript

  • Chapter 6
    Supply, Demand, and Government Policies
  • Examine the effects of government policies that place a ceiling on prices.
    Examine the effects of government policies that place a floor under prices.
    Consider how a tax on a good affects the price of the good and the quantity sold.
    Learn that taxes levied on buyers and taxes levied on sellers are equivalent.
    See how the burden of a tax is split between buyers and sellers.
    In this chapter you will…
  • In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
    While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
    Hence…market controls!
    One of the roles of economists is to use their theories to assist in the development of policies.
    SUPPLY, DEMAND, AND GOVERNMENT POLICIES
    View slide
  • Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
    Result in government-created price ceilings and floors.
    CONTROLS ON PRICES
    View slide
  • Price Ceiling
    A legal maximum on the price at which a good can be sold.
    Price Floor
    A legalminimum on the price at which a good can be sold.
    Price Ceilings and Price Floors
    • When the government imposes a price ceiling (i.e... a legal maximum on the price at which a good can be sold) two outcomes are possible
    The price ceiling is not binding.
    The price ceiling is a binding constraint on the market, creating Shortages.
    How Price Ceiling Affect Market Outcomes
  • Supply
    Supply
    Equilibrium price
    $4
    Price ceiling
    $3
    $3
    Price ceiling
    $2
    Equilibrium price
    Shortage
    Demand
    Demand
    75
    QS
    125
    QD
    100
    Equilibrium quantity
    Figure 6-1: A Market with a Price Ceiling
    (a) A Price Ceiling That is Not Binding
    (b) A Price Ceiling That is Binding
    Price of Ice-Cream Cone
    Price of Ice-Cream Cone
    0
    0
    Quantity of Ice-Cream Cones
    Quantity of Ice-Cream Cones
  • A binding price ceiling creates
    Shortages because QD > QS.
    Examples: Gasoline shortage of the 1970s, housing shortages with rent controls.
    Non-price rationing
    Examples: Long lines, discrimination by sellers, black markets.
    How Price Ceiling Affect Market Outcomes
  • 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.
    What was responsible for the long gas lines?
    Economists blame government regulations that limited the price oil companies could charge for gasoline.
    CASE STUDY:Lines at the Gas Pump
  • S2
    1. Initially the price ceiling is not binding…
    2.…but when supply falls…
    S1
    S1
    P2
    Price ceiling
    Price ceiling
    3.…the price ceiling becomes binding…
    P1
    P1
    4.…resulting in a shortage…
    Demand
    Demand
    QS
    Q1
    QD
    Figure 6-2: A Market for Gasoline with a Price Ceiling
    (a) A Price Ceiling on Gasoline is Not Binding
    (b) A Price Ceiling on Gasoline is Binding
    Price of Gasoline
    0
    Q1
    0
    Quantity of Gasoline
    Quantity of Gasoline
  • Rent controls are ceilings placed on the rents that landlords may charge their tenants.
    The goal of rent control policy is to help the poor by making housing more affordable.
    One economist called rent control “the best way to destroy a city, other than bombing.”
    CASE STUDY:Rent Control in the Short Run and Long Run
  • Supply
    Supply
    Controlled rent
    Controlled rent
    Shortage
    Shortage
    Demand
    Demand
    Figure 6-3: Rent Control in the Short Run and Long Run
    (a) Short Run (Supply and Demand are Inelastic)
    (b) Long Run (Supply and Demand are Elastic)
    Rental Price of Apartment
    Rental Price of Apartment
    0
    0
    Quantity of Apartments
    Quantity of Apartments
  • When the government imposes a price floor, two outcomes are possible.
    The price floor is not binding if set below the equilibrium price.
    The price floor is binding if set above the equilibrium price, leading to a surplus.
    How Price Floors Affect Market Outcomes
  • Supply
    Supply
    Surplus
    $4
    Equilibrium price
    Price ceiling
    $3
    $3
    Price Floor
    Equilibrium price
    $2
    Demand
    Demand
    80
    QD
    120
    QS
    100
    Equilibrium quantity
    Figure 6-4: A Market with a Price Floor
    (a) A Price Floor That is Not Binding
    (b) A Price Floor That is Binding
    Price of Ice-Cream Cone
    Price of Ice-Cream Cone
    0
    0
    Quantity of Ice-Cream Cones
    Quantity of Ice-Cream Cones
    • A Binding Price Floorcreates. . .
    Surpluses (i.e. Quantity Supplied > Quantity Demanded)
    Non-Price Rationing - An alternative mechanism for rationing of the good:
    • Discrimination Criteria
    Examples:
    • Minimum Wage
    • Agricultural Price Supports
    How Price Floors Affect Market Outcomes
  • 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.
    CASE STUDY:The Minimum Wage
  • Labour supply
    Labour surplus
    (unemployment)
    Labour supply
    Minimum wage
    Equilibrium wage
    Labour demand
    Labour demand
    Quantity supplied
    Quantity demanded
    Equilibrium employment
    Figure 6-5: How the Minimum Wage Affects the Labour Market
    (a) A Free Labour Market
    (b) A Labour Market with a Binding Minimum Wage
    Wage
    Wage
    0
    0
    Quantity of Labour
    Quantity of Labour
    • What is the purpose of government- imposed taxes?
    To raise government revenues.
    To restrict production of a product.
    • What is an excise tax?
    A “per-unit” tax that’s independent of the price of the product.
    TAXES
    • Who pays the tax on a good? The buyer or the seller?
    • How is the burden of a tax divided between buyer and seller?
    • When the government levies a tax on a good, the equilibrium quantity of the good falls. The size of the market for that good shrinks, shifting either the demand or supply curve.
    • Tax incidence: The study of who bears the burden of taxation.
    TAXES
  • Taxes discourage market activity.
    When a good is taxed, the quantity sold is smaller.
    Buyers and sellers share the tax burden.
    How Taxes on Buyers (and Sellers) Affect Market Outcomes
  • S1
    Price buyers pay
    $3.30
    Price without tax
    Tax ($0.50)
    Equilibrium without tax
    $3.00
    A tax on buyers shifts the demand curve downward by size of the tax ($0.50).
    $2.80
    Price sellers receive
    Equilibrium with tax
    D1
    D2
    90
    100
    Figure 6-6: A Tax on Buyers
    Price of Ice-Cream Cone
    0
    Quantity of Ice-Cream Cone
  • S2
    S1
    Equilibrium with tax
    Price buyers pay
    A tax on sellers shifts the supply curve upward by an amount of the tax ($0.50).
    $3.30
    Price without tax
    Tax ($0.50)
    Equilibrium without tax
    $3.00
    $2.80
    Price sellers receive
    D1
    90
    100
    Figure 6-7: A Tax on Sellers
    Price of Ice-Cream Cone
    0
    Quantity of Ice-Cream Cone
  • Example: Employment Insurance.
    A payroll tax places a wedge between the wage the workers receive and the wage the firm pays.
    CASE STUDY:The Burden of a Payroll tax
  • Labour supply
    Wage firms pay
    Tax wedge
    Wage without tax
    Wage workers receive
    Labour demand
    Figure 6-8: A Payroll Tax
    Wage
    0
    Quantity of Labour
    • Consider a tax levied on sellers of a good. What are the effects of this tax?
    • How do effects of the tax levied on the seller compare with those of the effects imposed on the buyer?
    • Depends on Elasticity of Demand andElasticity of Supply.
    Elasticity and Tax incidence
    • The burden of a tax falls on the side of the market with the smaller price elasticity!
    • The moreinelasticthe demand and the more elastic the supply results in the consumer paying more of the tax.
    • The more elasticthe demand and the moreinelasticthe supply results in the supplier paying more of the tax.
    Elasticity and Tax incidence
  • 1. When supply is more elastic than demand …
    Price buyers pay
    Supply
    Tax
    Price without tax
    2. …the incidence of the tax falls more heavily on consumers…
    Price sellers receive
    Demand
    3. …than on producers.
    Figure 6-9 a): How the Burden of a Tax is Divided.
    Price
    Elastic Supply, Inelastic Demand
    Quantity
  • Supply
    1. When demand is more elastic than supply …
    Price buyers pay
    3. …than on consumers.
    Tax
    Demand
    Price without tax
    2. …the incidence of the tax falls more heavily on producers…
    Price sellers receive
    Figure 6-9 b): How the Burden of a Tax is Divided
    Price
    Inelastic Supply, Elastic Demand
    Quantity
  • Price controls include price ceilings and price floors.
    A price ceiling is a legal maximum on the price of a good or service. An example is rent control.
    A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage.
    Summary
  • Taxes are used to raise revenue for public purposes.
    When the government levies a tax on a good, the equilibrium quantity of the good falls.
    A tax on a good places a wedge between the price paid by buyers and the price received by sellers.
    Summary
  • The incidence of a tax refers to who bears the burden of a tax.
    The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.
    The incidence of the tax depends on the price elasticities of supply and demand.
    The burden tends to fall on the side of the market that is less elastic.
    Summary
  • The End