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Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Repealing the Laws of Supply and Demand: Price Controls Price Ceiling u A legally.

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Presentation on theme: "Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Repealing the Laws of Supply and Demand: Price Controls Price Ceiling u A legally."— Presentation transcript:

1 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Repealing the Laws of Supply and Demand: Price Controls Price Ceiling u A legally established maximum price at which a good can be sold. Price Floor u A legally established minimum price at which a good can be sold.

2 A Price Ceiling That Is Not Binding... $4 3 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply Price ceiling Equilibrium price 100 Equilibrium quantity Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

3 A Price Ceiling That Is Binding... $3 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 2 Demand Supply Equilibrium price Price ceiling Shortage 125 Quantity demanded 75 Quantity supplied Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

4 The 1970s Energy Crisis: The Price Ceiling on Gasoline P1P1 Quantity of Gasoline 0 Price of Gasoline Q1Q1 Demand S1S1 Price ceiling S2S2 2. …but when supply falls... P2P2 3. …the price ceiling becomes binding …resulting in a shortage.

5 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Rent Control in the Short Run... Quantity of Apartments 0 Rental Price of Apartment Demand Supply Controlled rent Shortage Supply and demand for apartments are relatively inelastic

6 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Rent Control in the Long Run... Quantity of Apartments 0 Rental Price of Apartment Demand Supply Controlled rent Shortage Because the supply and demand for apartments are more elastic... …rent control causes a large shortage

7 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Minimum Wage: An important example of a price floor …

8 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Free Labor Market Quantity of Labor 0 Wage Equilibrium wage Labor demand Labor supply Equilibrium employment

9 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Minimum wage The Minimum Wage Quantity of Labor 0 Wage Labor demand Labor supply Quantity supplied Quantity demanded Labor surplus (unemployment) A Labor Market with a Minimum Wage

10 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. n What are the equilibrium price and quantity of Frisbees? n Frisbee manufacturers persuade the government that Frisbee production improves scientists understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees are sold? n Irate college students march on Washington and demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former price floor. What is the new market price? How many Frisbees are sold?

11 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Taxes Governments levy taxes to raise revenue for public needs.

12 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. What are some potential impacts of taxes? u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Buyers and sellers share the tax burden.

13 Impact of a 50¢ Tax Levied on Buyers Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 100 D1D1 Supply, S 1 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). D2D2 Copyright © 2001 by Harcourt, Inc. All rights reserved

14 3.00 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone $3.30 Price buyers pay D1D1 D2D2 Equilibrium with tax Supply, S 1 Equilibrium without tax Impact of a 50¢ Tax Levied on Buyers Price sellers receive Copyright © 2001 by Harcourt, Inc. All rights reserved Price without tax Tax ($0.50)

15 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. What was the impact of tax? u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Tax puts a wedge between the price buyers pay and the price sellers receive. u Buyers and sellers share the tax burden.

16 3.00 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone S1S1 S2S2 Demand, D 1 Impact of a 50¢ Tax on Sellers... Price without tax 2.80 Price sellers receive $3.30 Price buyers pay Equilibrium without tax Copyright © 2001 by Harcourt, Inc. All rights reserved A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). Tax ($0.50) Equilibrium with tax

17 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. What was the impact of tax? u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Tax puts a wedge between the price buyers pay and the price sellers receive. u Buyers and sellers share the tax burden.

18 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elastic Supply, Inelastic Demand... Quantity0 Price Demand Supply Tax 1. When supply is more elastic than demand the incidence of the tax falls more heavily on consumers than on producers. Price without tax Price buyers pay Price sellers receive

19 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Inelastic Supply, Elastic Demand... Quantity0 Price Demand Supply Price without tax Tax 1. When demand is more elastic than supply the incidence of the tax falls more heavily on producers than on consumers. Price buyers pay Price sellers receive

20 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. So, how is the burden of the tax divided? n The burden of a tax falls more heavily on the side of the market that is less elastic. n If you cant easily adjust, youre stuck paying most of the tax.

21 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Price controls include price ceilings and price floors. u A price ceiling is a legal maximum on the price of a good or service. An example is rent control. u A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage.

22 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u Taxes are used to raise revenue for public purposes. u When the government levies a tax on a good, the equilibrium quantity of the good falls. u A tax on a good places a wedge between the price paid by buyers and the price received by sellers.

23 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Summary u The incidence of a tax refers to who bears the burden of a tax. u The incidence of a tax does not depend on whether the tax is levied on buyers or sellers. u The incidence of the tax depends on the price elasticities of supply and demand.

24 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Graphical Review

25 A Price Ceiling That Is Not Binding... $4 3 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply Price ceiling Equilibrium price 100 Equilibrium quantity Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

26 A Price Ceiling That Is Binding... $3 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 2 Demand Supply Equilibrium price Price ceiling Shortage 125 Quantity demanded 75 Quantity supplied Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

27 The Price Ceiling on Gasoline Is Not Binding... $4 P1P1 Quantity of Gasoline 0 Price of Gasoline Q1Q1 Demand Supply Price ceiling 1. Initially, the price ceiling is not binding...

28 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Price Ceiling on Gasoline Is Binding... P1P1 Quantity of Gasoline 0 Price of Gasoline Q1Q1 Demand S1S1 Price ceiling S2S2 2. …but when supply falls... P2P2 3. …the price ceiling becomes binding …resulting in a shortage.

29 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Rent Control in the Short Run... Quantity of Apartments 0 Rental Price of Apartment Demand Supply Controlled rent Shortage Supply and demand for apartments are relatively inelastic

30 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Rent Control in the Long Run... Quantity of Apartments 0 Rental Price of Apartment Demand Supply Controlled rent Shortage Because the supply and demand for apartments are more elastic... …rent control causes a large shortage

31 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Price Floor That Is Not Binding... $3 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 100 Equilibrium quantity Equilibrium price Demand Supply Price floor 2

32 A Price Floor That Is Binding... $3 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium price Demand Supply Price floor$4 120 Quantity supplied 80 Quantity demanded Surplus Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

33 The Minimum Wage Quantity of Labor 0 Wage Equilibrium wage Labor demand Labor supply A Free Labor Market Equilibrium employment

34 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. The Minimum Wage Minimum wage Quantity of Labor 0 Wage Labor demand Labor supply Quantity supplied Quantity demanded Labor surplus (unemployment) A Labor Market with a Minimum Wage

35 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Impact of a 50¢ Tax Levied on Buyers Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone 100 D1D1 Supply, S 1 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). D2D2

36 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Impact of a 50¢ Tax Levied on Buyers Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone $3.30 Price buyers pay D1D1 D2D2 Equilibrium with tax Supply, S 1 Equilibrium without tax 2.80 Price sellers receive Price without tax Tax ($0.50)

37 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Impact of a 50¢ Tax on Sellers Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone S1S1 S2S2 Demand, D 1 Price without tax 2.80 Price sellers receive $3.30 Price buyers pay Equilibrium without tax A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). Tax ($0.50) Equilibrium with tax

38 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Payroll Tax Quantity of Labor 0 Wage Wage without tax Labor demand Labor supply Tax wedge Wage firms pay Wage workers receive

39 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Elastic Supply, Inelastic Demand... Quantity0 Price Demand Supply Tax 1. When supply is more elastic than demand the incidence of the tax falls more heavily on consumers than on producers. Price without tax Price buyers pay Price sellers receive

40 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Inelastic Supply, Elastic Demand... Quantity0 Price Demand Supply Price without tax Tax 1. When demand is more elastic than supply the incidence of the tax falls more heavily on producers than on consumers. Price buyers pay Price sellers receive


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