More Related Content
What's hot
What's hot (18)
Viewers also liked
Viewers also liked (18)
Similar to Ch06macmic,d&s g ov,t policy
Similar to Ch06macmic,d&s g ov,t policy (20)
Recently uploaded
Recently uploaded (20)
Ch06macmic,d&s g ov,t policy
- 1. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply, Demand, and Government Policies Principles of Economics Chapter 6 N.Gregory Mankiw © 2002 by Nelson, a division of Thomson Canada Limited
- 2. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Overview The Effects of Price Controls The Effects of an Excise Tax
- 3. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply, Demand and Government Policies 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, i.e. buyer or seller are satisfied. Hence, market controls!
- 4. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Burkhas in Afghanistan Once the Taliban was ousted, demand for burkhas fell as many women quit wearing them. At P0 quantity supplied > quantity demanded. Price fell to P1 until quantity demanded = quantity supplied. S P0 Q0Q1 P1 D0 D1 Excess Supply
- 5. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Price Controls Are usually enacted when policy-makers believe that the market price is unfair to buyers and sellers. Result in government policies, i.e. price ceilings and floors.
- 6. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Government Intervention as Implicit Taxation Government intervention in the form of price controls can be viewed as a combination tax and subsidy. A price ceiling is an implicit tax on producers and an implicit subsidy to producers that causes a welfare loss identical to the loss from taxation. A price floor is a tax on consumers and a subsidy for producers that transfers consumer surplus to producers.
- 7. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Price Ceilings & Price Floors A Price Ceiling –is a legally established maximum price which a seller can charge or a buyer must pay. A Price Floor –is a legally established minimum price which a seller can charge or a buyer must pay.
- 8. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Price Ceilings 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: 1. The price ceiling is not binding. 2. The price ceiling is a binding constraint on the market, creating Shortages.
- 9. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Ceiling Supply Demand Price Quantity Equilibrium Price Equilibrium Quantity
- 10. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Non-Binding Price Ceiling Supply Demand Price Quantity PE QE Price Ceiling PC
- 11. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Ceiling Supply Demand Price Quantity PE QE Price Ceiling PC
- 12. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Ceiling Creates Shortages. Supply Demand Price Quantity PE QE PC QS QD
- 13. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Ceiling Creates Shortages. Supply Demand Price Quantity PE QE PC QS QD Shortage
- 14. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Ceiling A Binding Price Ceiling creates. . . –Shortages (i.e... Demand > Supply) Gasoline shortages of the 1970s Housing shortages with rent controls –Non-Price Rationing - An alternative mechanism for rationing of the good: Long Lines (first-In-Line, friends etc.) Discrimination criteria set by seller Black markets
- 15. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Price Floors When the government imposes a price floor (i.e... a legal minimum on the price at which a good can be sold) two outcomes are possible: 1. The price floor is not binding. 2. The price floor is a binding constraint on the market, creating Surpluses.
- 16. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Non-Binding Price Floor Supply Demand Price Quantity PE QE Price Floor PF
- 17. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Floor Supply Demand Price Quantity PE QE Price Floor PF
- 18. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Floor A government-imposed market price floor hinders the forces of supply and demand in moving toward the equilibrium price and quantity. When the market price hits the floor, it can fall no further and the market price equals the floor price. A binding price floor causes a surplus.
- 19. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Floor Creates a Surplus. Supply Demand Price Quantity PE QE PF QS QD
- 20. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply Demand Price Quantity PE QE PF QS QD Surplus A Binding Price Floor Creates a Surplus.
- 21. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Floor A Binding Price Floor creates. . . –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
- 22. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Effect of a Price Ceiling P0 Q0 Quantity Price Q1 S DProducer surplus Consumer surplus Welfare loss P1 Price ceiling Transferred to consumers F D C E B A
- 23. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Effect of a Price Floor P0 Q0 Quantity Price Q1 S DProducer surplus Consumer surplus Welfare loss Transferred to producers F D C E B A P1 Price floor
- 24. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Government Intervention in the Market Buyers look to the government for ways to hold prices down. A price ceiling is a government-imposed limit on how high a price can be charged. Sellers look to the government for ways to hold prices up. A price floor is a government-imposed limit on how low a price can be charged.
- 25. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition 2.50 Shortage Rent Controls Rent control is a price ceiling on rents set by the government. Rent control in Paris after World War I created a housing shortage. The shortage would have been eliminated if rents had been allowed to rise to $17 per month. QS QD S D RentalPrice(permonth) Quantity of apartments $17.00
- 26. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Minimum Wage The minimum wage, a price floor, is set by government specifying the lowest wage a firm can legally pay. A minimum wage, Wmin, above the equilibrium wage, We, helps those who are employed, Q2, but hurts those who would have been employed at We, but can no longer find employment, Qe- Q2. Wmin We Q2 Qe Q1 S D Quantity of Workers Wageperhour
- 27. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Quick Quiz! Define “price ceiling” and “price floor” Give an example of each. Which leads to a shortage, which a surplus? Why?
- 28. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Overview The Effects of Price Controls The Effects of an Excise Tax
- 29. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes! Taxes! Taxes! 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.
- 30. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes! Taxes! 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.
- 31. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Producer and Consumer Surplus Consumer surplus - the value the consumer gets from buying a product, less its price. – It is the area below the demand curve and above the price. Producer surplus – the value the producer sells a product for less the cost of producing it. – It is the area above the supply curve but
- 32. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Producer and Consumer Surplus Price S D Quantity 0 $10 9 8 7 6 5 4 3 2 1 10987654321 Producer Surplus Consumer Surplus CS = ½(5x5) = 12.5 = Area of blue triangle PS = ½(5x5) = 12.5 = Area of red triangle The combination of producer and consumer surplus is maximized at market equilibrium.
- 33. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Producer and Consumer Surplus Price S D Quantity 0 $10 9 8 7 6 5 4 3 2 1 10987654321 Producer Surplus gains 2x4 = 8 units of lost consumer surplus If price is $6, Consumer Surplus: CS = 1/2 ($4x4) = $8 Combined consumer and producer surplus decreases when price is above equilibrium. Lost surplus = ½($2x1) = $1
- 34. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxation and Government For government to operate, it must tax. For the market to work, it needs the government. Tax rates depend on what goods and services government provides.
- 35. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact Taxes discourage market activity. The quantity of the good sold is smaller than without the tax. Buyers and sellers share the tax burden.
- 36. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1 $3.00 800 D1 Equilibrium without tax Quantity Price
- 37. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1 $3.00 800 D1 From the sellers viewpoint, the tax causes the demand curve to shift down by 50 cents. $2.80 600 Price Quantity
- 38. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1 $3.00 800 $3.30 600 The tax increases the market price to the buyer... $2.80 D1 Quantity Price
- 39. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1 $3.00 800 $3.30 600 The tax increases the market price to the buyer... …in this case the price rises $.30. $2.80 D1Price Quantity
- 40. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1 $3.00 800 $3.30 600 The tax decreases the return to the seller as the seller gets $.20 less. $2.80 D1 Quantity Price
- 41. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1 $3.00 800 $3.30 600 The tax makes both the buyer and the seller worse off!$2.80 D1 Quantity Price
- 42. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition The Incidence of Tax. . .How is the burden of the tax distributed? 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 and Elasticity of Supply.
- 43. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition The Incidence of Tax. . .How is the burden of the tax distributed? The burden of a tax falls on the side of the market with the smaller price elasticity!
- 44. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Taxes The more inelastic the demand and the more elastic the supply results in the consumer paying more of the tax. The more elastic the demand and the more inelastic the supply results in the supplier paying more of the tax.
- 45. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax Example: A more inelastic demand and more elastic supply. Supply Demand $2.00 250 Price Quantity
- 46. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.00 $2.15 200 250 Price Quantity
- 47. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.15 $2.00 $1.95 200 250 Producer’s burden of tax Price Quantity
- 48. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.15 $2.00 $1.95 200 250 Buyer’s burden of tax Price Quantity
- 49. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Excise Taxes Quantity of luxury boats 0 Priceofluxuryboats 65,000 510 S1 D S0 A $10,000 excise tax on luxury boats shifts the supply curve up by $10,000. 60,000 420 $70,000 600 At $70,000, there is excess supply of 600- 420 = 180. The price of the boats rises by less than the tax to $65,000.
- 50. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Quantity Restrictions In 1937 New York City limited the number of taxi licenses to 12,000 to increase the wages of taxi drivers. Because taxi medallions were limited in supply, as demand for taxi services rose, so did the demand for medallions, increasing their price to $2500 by 1947. Today, medallions sell for $300,000!
- 51. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition The Costs of Taxation To determine how much to tax, the government must determine the costs and benefits of taxation. The costs of taxation include: – Direct cost of revenue paid to the government – Deadweight loss - loss of consumer and producer surplus that is not gained by the government – Administrative costs of compliance – resources used by the government to
- 52. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Costs of Taxation S1 P1–t Quantity Price P0 Q0 P1 Q1 Producer surplus S0 D Consumer surplus Deadweight loss tax A per unit tax t paid by the suppliers shifts the supply curve from S0 to S1 and in- creases price to P1 and decreases quantity to Q1. Consumer surplus is A+B+C before the tax and A after the tax. Producer surplus is D+E+F before the tax and F after the tax. Government revenue=B+D Deadweight loss=C+E F ED C B A
- 53. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition The Benefits of Taxation The benefits of taxation are the goods and services that government provides. – Provides a stable set of institutions and rules – Promotes effective and workable competition – Corrects for externalities – Creates an environment that fosters stability and growth – Provides public goods – Adjusts for undesirable market results
- 54. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Two Principles of Taxation The benefits principle – the individuals who receive the benefit of the good or service should pay the tax necessary to supply the good. The ability-to-pay principle – individuals who are most able to bear the burden of the tax should pay.
- 55. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Tax Burden The person who physically pays the tax is not necessarily the person who bears the burden of the tax. The more inelastic one’s relative demand and supply, the larger the tax burden one will bear. – If demand is more inelastic than supply, consumers will pay the higher share. – If supply is more inelastic than demand, suppliers will pay the higher share.
- 56. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Who Bears the Tax Burden? Demand is elastic Equal burden Priceofluxuryboats Quantity of luxury boats 0 510 S1D S0 60 $70 600 50 40 Priceofluxuryboats Quantity of luxury boats 0 500 S1D S0 60 $70 600 50 40 tax Demand is inelastic Larger consumer burden 590
- 57. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Who Bears the Tax Burden? Supplier pays the tax- Supply shifts Priceofluxuryboats Quantity of luxury boats 0 510 S1D S0 60 $70 600 50 40 tax Priceofluxuryboats Quantity of luxury boats 0 510 D0 S 60 $70 600 50 40 tax D1 Consumer pays the tax- Demand shifts Tax burden is independent of who pays the tax.
- 58. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply, Demand & Government The economy is governed by two kinds of laws: –The laws of supply and demand –The laws enacted by government Price controls and taxes are common in various markets in the economy: –Price Ceilings –Price Floors –Excise Tax
- 59. Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Overview The Effects of Price Controls The Effects of an Excise Tax