1 Supply, Demand and Government PoliciesChapter 6
2 Supply, Demand, and Government PoliciesIn 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. One of the roles of economists is to use their theories to assist in the development of policies. 2 2
3 Controls on Price... Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Result in government-created price ceilings and floors. 3 3
4 Controls on Price... Price Ceiling A legally established maximum price at which a good can be sold. Price Floor A legally established minimum price at which a good can be sold. 4 4
5 How Price Ceilings Affect Market OutcomesTwo outcomes are possible when the government imposes a price ceiling: The price ceiling is not binding if set above the equilibrium price. The price ceiling is binding if set below the equilibrium price, leading to a shortage. 5 5
6 A Price Ceiling That Is Not Binding...Price of Ice-Cream Cone Supply $4 Price ceiling 3 Equilibrium price Demand 100 Quantity of Ice-Cream Cones Equilibrium quantity 6 7
7 A Price Ceiling That Is Binding...Price of Ice-Cream Cone Supply Equilibrium price $3 2 Price ceiling 75 Quantity supplied 125 Quantity demanded Shortage Demand Quantity of Ice-Cream Cones 7 10
8 How Price Ceilings Affect Market OutcomesEffects of Price Ceilings A binding price ceiling creates ... shortages because QD > QS. Example: Gasoline shortage of the 1970s nonprice rationing Examples: Long lines, Discrimination by sellers 11 14
9 What was responsible for the long gas lines?Lines at the Gas Pump In 1973 OPEC raised the price of crude oil in world markets. Because crude oil is the major input used to make gasoline, 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.
10 The Price Ceiling on Gasoline Is Not Binding...Price of Gasoline 1. Initially, the price ceiling is not binding... Supply $4 Price ceiling P1 Demand Quantity of Gasoline Q1 6 7
11 The Price Ceiling on Gasoline Is Binding...Price of Gasoline 2. …but when supply falls... S1 P2 Price ceiling 4. …resulting in a shortage. 3. …the price ceiling becomes binding... P1 Demand Quantity of Gasoline Q1 6 7
12 Rent Control in the Short Run and Long RunRent 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.” 2
13 Rent Control in the Short Run...Rental Price of Apartment Supply and demand for apartments are relatively inelastic Supply Controlled rent Shortage Demand Quantity of Apartments 7 10
14 Rent Control in the Long Run...Because the supply and demand for apartments are more elastic... Rental Price of Apartment Supply …rent control causes a large shortage Controlled rent Shortage Demand Quantity of Apartments 7 10
15 How Price Floors Affect Market OutcomesWhen 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. 12 15
16 A Price Floor That Is Not Binding...Price of Ice-Cream Cone Supply Equilibrium price $3 Price floor 2 Demand 100 Quantity of Ice-Cream Cones Equilibrium quantity 8 17
17 A Price Floor That Is Binding...Price of Ice-Cream Cone Supply Surplus $4 Price floor 80 Quantity demanded 120 Quantity supplied $3 Equilibrium price Demand Quantity of Ice-Cream Cones 8 17
18 How Price Floors Affect Market OutcomesA price floor prevents supply and demand from 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. 15 24
19 How Price Floors Affect Market OutcomesA binding price floor causes . . . a surplus because QS >QD. nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. Examples: The minimum wage, Agricultural price supports 15 25
20 The Minimum Wage 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.
21 The Minimum Wage A Free Labor Market Labor supply Labor demand WageEquilibrium Wage Equilibrium Employment Labor demand Quantity of Labor
22 How the Minimum Wage Affects the Labor MarketA Labor Market with a Minimum Wage Wage Labor supply Labor surplus (unemployment) Minimum wage Quantity demanded Quantity supplied Labor demand Quantity of Labor
23 Governments levy taxes to raise revenue for public projects.20 29
24 How Taxes on Buyers (and Sellers) Affect Market OutcomesTaxes discourage market activity. When a good is taxed, the quantity sold is smaller. Buyers and sellers share the tax burden. 22 30
25 Elasticity and Tax IncidenceTax incidence is the study of who bears the burden of a tax. Taxes result in a change in market equilibrium. Buyers pay more and sellers receive less, regardless of whom the tax is levied on. 21 31
26 Impact of a 50¢ Tax Levied on Buyers...Price of Ice-Cream Cone Supply, S1 D2 3.00 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). D1 100 Quantity of Ice-Cream Cones 23 33
27 Impact of a 50¢ Tax Levied on Buyers...Price of Ice-Cream Cone Supply, S1 $3.30 Price buyers pay Equilibrium without tax Tax ($0.50) Price without tax 3.00 2.80 Price sellers receive Equilibrium with tax D1 D2 90 100 Quantity of Ice-Cream Cones 23 38
28 What was the impact of tax?Taxes discourage market activity. When a good is taxed, the quantity sold is smaller. Buyers and sellers share the tax burden. 22 30
29 Impact of a 50¢ Tax on Sellers...Price of Ice-Cream Cone A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). $3.30 Price buyers pay S2 Equilibrium with tax S1 90 Tax ($0.50) 3.00 Price without tax Equilibrium without tax 2.80 Price sellers receive Demand, D1 100 Quantity of Ice-Cream Cones
30 A Payroll Tax Labor supply Labor demand Wage Wage firms pay Tax wedgeWage without tax Wage workers receive Labor demand Quantity of Labor
31 Elasticity and Tax IncidenceIn what proportions is the burden of the tax divided? How do the effects of taxes on sellers compare to those levied on buyers? The answers to these questions depend on the elasticity of demand and the elasticity of supply. 29 39
32 （a）Elastic Supply, Inelastic Demand...Figure 9 How the Burden of a Tax Is Divided （a）Elastic Supply, Inelastic Demand... Price 1. When supply is more elastic than demand... Price buyers pay Tax 2. ...the incidence of the tax falls more heavily on consumers... Supply Price without tax 3. ...than on producers. Price sellers receive Demand Quantity 32 44
33 (b)Inelastic Supply, Elastic Demand...Figure 9 How the Burden of a Tax Is Divided (b)Inelastic Supply, Elastic Demand... 1. When demand is more elastic than supply... Price Supply Price buyers pay Tax 3. ...than on consumers. Price without tax 2. ...the incidence of the tax falls more heavily on producers... Demand Price sellers receive Quantity 32 51
34 So, how is the burden of the tax divided?ELASTICITY AND TAX INCIDENCE So, how is the burden of the tax divided? The burden of a tax falls more heavily on the side of the market that is less elastic. 30 41
35 Summary 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.
36 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.
37 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.