Presentation on theme: "Supply, Demand, and Government Policies"— Presentation transcript:
1 Supply, Demand, and Government Policies 6Supply, Demand, and Government Policies
2 Controls on Prices How price ceilings affect market outcomes Legal maximum on the price at which a good can be soldNot bindingAbove the equilibrium priceNo effectBinding constraintBelow the equilibrium priceShortageSellers must ration the scarce goodsThe rationing mechanisms – not desirable
3 A market with a price ceiling 1A market with a price ceiling(a) A price ceiling that is not binding(b) A price ceiling that is bindingPrice ofIceCreamConesPrice ofIceCreamConesSupplySupplyDemandDemand$4Price ceilingEquilibriumprice3$3Equilibriumprice1002Price ceiling75125ShortageEquilibriumquantityQuantitysuppliedQuantitydemandedQuantity of Ice-Cream ConesQuantity of Ice-Cream ConesIn panel (a), the government imposes a price ceiling of $4. Because the price ceiling is above the equilibrium price of $3, the price ceiling has no effect, and the market can reach the equilibrium of supply and demand. In this equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price ceiling of $2. Because the price ceiling is below the equilibrium price of $3, the market price equals $2. At this price, 125 cones are demanded and only 75 are supplied, so there is a shortage of 50 cones.
4 1973, OPEC raised the price of crude oil Lines at the gas pump1973, OPEC raised the price of crude oilReduced the supply of gasolineLong lines at gas stationsWhat was responsible for the long gas lines?OPEC: created shortage of gasolineU.S. government regulations: price ceiling on gasolineBefore OPEC raised the price of crude oilEquilibrium price - below price ceiling: no effectWhen the price of crude oil roseEquilibrium price – above price ceiling: shortage
5 The market for gasoline with a price ceiling 2The market for gasoline with a price ceilingThe price ceiling on gasolineis not binding(b) The price ceiling on gasolineis bindingPrice ofGasolinePrice ofGasoline2…but when supply falls…S21. Initially, the price ceiling is not binding …DemandDemandSupply, S1S1P2Price ceilingPrice ceilingQSQD3…the price ceiling becomes binding…4. …resulting in a shortageP1P1Q1Q1Quantity of GasolineQuantity of GasolinePanel (a) shows the gasoline market when the price ceiling is not binding because the equilibrium price, P1, is below the ceiling. Panel (b) shows the gasoline market after an increase in the price of crude oil (an input into making gasoline) shifts the supply curve to the left from S1 to S2. In an unregulated market, the price would have risen from P1 to P2. The price ceiling, however, prevents this from happening. At the binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS. The difference between quantity demanded and quantity supplied, QD – QS, measures the gasoline shortage.
6 Rent control in the short run and the long run Price ceiling: rent controlLocal government - ceiling on rentsGoal: help the poor (housing more affordable)Critique: highly inefficient way to help the poor raise their standard of livingAdverse effects of rent control in the short runSupply and demand for housing - relatively inelasticInitial small shortageReduce rents
7 Rent control in the short run and the long run Adverse effects of rent control in the long runSupply and demand - more elasticLandlords - not building new apartments & failing to maintain existing onesPeople - find their own apartments & induce more people to move into a cityLarge shortage of housingRationing mechanismsLong waiting listsPreference to tenants without childrenDiscriminate on the basis of raceBribes to building superintendents
8 Rent control in the short run and in the long run 3Rent control in the short run and in the long run(a) Rent Control in the Short Run(supply and demand are inelastic)(b) Rent Control in the Long Run(supply and demand are elastic)RentalPrice ofApartmentRentalPrice ofApartmentSupplyDemandSupplyDemandControlled rentControlled rentShortageShortageQuantity of ApartmentsQuantity of ApartmentsPanel (a) shows the short-run effects of rent control: Because the supply and demand for apartments are relatively inelastic, the price ceiling imposed by a rent-control law causes only a small shortage of housing. Panel (b) shows the long-run effects of rent control: Because the supply and demand for apartments are more elastic, rent control causes a large shortage.
9 Rent control in the short run and the long run People respond to incentivesFree marketsLandlords try to keep their buildings clean and safeHigher pricesRent control – shortages & waiting listsLandlords lose their incentive to respond to tenants’ concernsTenants get lower rents & lower-quality housing.Policymakers – additional regulationsDifficult and costly to enforce
10 Controls on Prices How price floors affect market outcomes Price floor Legal minimum on the price at which a good can be soldNot bindingBelow the equilibrium priceNo effectBinding constraintAbove the equilibrium priceSurplusSome seller are unable to sell what they wantThe rationing mechanisms – not desirable
11 A market with a price floor 4A market with a price floor(a) A price floor that is not binding(b) A price floor that is bindingPrice ofIceCreamConePrice ofIceCreamConeSurplusSupplyDemandSupplyDemand$4Price floor80120$33Equilibriumprice100Equilibriumprice2Price floorEquilibriumquantityQuantitydemandedQuantitysuppliedQuantity of Ice-Cream ConesQuantity of Ice-Cream ConesIn panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and only 80 are demanded, there is a surplus of 40 cones.
12 Price floor: minimum wage Fair Labor Standards Act of 1938 The minimum wagePrice floor: minimum wageLowest price for labor that any employer may payFair Labor Standards Act of 1938Ensure workers a minimally adequate standard of living2007: minimum wage = $5.15 per hourScheduled to increase to $7.25 by 2010
13 If minimum wage – above equilibrium The minimum wageMarket for laborWorkers - supply of laborFirms – demand for laborIf minimum wage – above equilibriumUnemploymentHigher income - workers who have jobsLower income - workers who cannot find jobs
14 Impact of the minimum wage Workers with high skills and much experienceNot affected: Equilibrium wages - above the minimumMinimum wage - not bindingTeenage labor – least skilled and least experiencedLow equilibrium wagesWilling to accept a lower wage in exchange for on-the-job trainingMinimum wage – binding
15 How the minimum wage affects the labor market 5How the minimum wage affects the labor market(a) A free labor market(b) A Labor Market with aBinding Minimum WageWageWageLaborsupplyLaborsupplyLabor surplus(unemployment)LabordemandLabordemandMinimumwageQuantitydemandedQuantitysuppliedEquilibriumwageEquilibriumemploymentQuantityof LaborQuantityof LaborPanel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. The result is unemployment.
16 Controls on Prices Evaluating price controls Markets are usually a good way to organize economic activityEconomists usually oppose price ceilings and price floorsPrices – coordinate economic activity
17 Controls on Prices Evaluating price controls Governments can sometimes improve market outcomesPrice controls - because of unfair market outcomeAimed at helping the poorOften hurt those they are trying to helpOther ways of helping those in needRent subsidiesWage subsidies
18 Taxes Tax incidence How taxes on sellers affect market outcomes Manner in which the burden of a tax is shared among participants in a marketHow taxes on sellers affect market outcomesImmediate impact on sellersShift in supplySupply curve shifts leftHigher equilibrium priceLower equilibrium quantityThe tax – reduces the size of the market
19 6 A tax on sellers Price of A tax on sellers Ice-Cream ConeA tax on sellersshifts the supplycurve upwardby the size ofthe tax ($0.50).Demand, D1Equilibrium with taxS2PricebuyerspayS1$3.30PricewithouttaxTax($0.50)903.00Equilibrium without tax1002.80PricesellersreceiveQuantity ofIce-Cream ConesWhen a tax of $0.50 is levied on sellers, the supply curve shifts up by $0.50 from S1 to S2. The equilibrium quantity falls from 100 to 90 cones. The price that buyers pay rises from $3.00 to $3.30. The price that sellers receive (after paying the tax) falls from $3.00 to $2.80. Even though the tax is levied on sellers, buyers and sellers share the burden of the tax.
20 Taxes How taxes on sellers affect market outcomes Taxes discourage market activitySmaller quantity soldBuyers and sellers share the burden of taxBuyers pay moreWorse offSellers receive lessGet the higher price but pay the taxOverall: effective price fall
21 Taxes How taxes on buyers affect market outcomes Initial impact on the demandDemand curve shifts leftLower equilibrium priceLower equilibrium quantityThe tax – reduces the size of the market
22 7 A tax on buyers Price of Ice-Cream Cone Equilibrium with tax Price D1Equilibrium with taxPricebuyerspaySupply, S1Equilibrium without taxD2$3.30PricewithouttaxTax($0.50)90A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).3.001002.80PricesellersreceiveQuantity ofIce-Cream ConesWhen a tax of $0.50 is levied on buyers, the demand curve shifts down by $0.50 from D1 to D2. The equilibrium quantity falls from 100 to 90 cones. The price that sellers receive falls from $3.00 to $2.80. The price that buyers pay (including the tax) rises from $3.00 to $3.30. Even though the tax is levied on buyers, buyers and sellers share the burden of the tax.
23 Taxes How taxes on buyers affect market outcomes Buyers and sellers share the burden of the taxSellers get a lower priceWorse offBuyers pay a lower market priceEffective price (with tax) risesTaxes levied on sellers and taxes levied on buyers are equivalent
24 Can congress distribute the burden of a payroll tax? Payroll taxesDeducted from the amount you earnedBy law, the tax burden:Half of the tax - paid by firmsOut of firm’s revenueHalf of the tax - paid by workersDeducted from workers’ paychecksTax incidence analysisPayroll tax = tax on a goodGood = laborPrice = wage
25 Can congress distribute the burden of a payroll tax? Introduce payroll taxWage received by workers fallsWage paid by firms risesWorkers and firms share the burden of the taxNot necessarily fifty-fifty as the legislation requiresLawmakersCan decide whether a tax comes from the buyer’s pocket or from the seller’sCannot legislate the true burden of a taxTax incidence: forces of supply and demand
26 8 A payroll tax Wage Labor supply Wage firms pay Wage without tax demandWage firms payTaxwedgeWage without taxWage workersreceiveQuantity ofLaborA payroll tax places a wedge between the wage that workers receive and the wage that firms pay. Comparing wages with and without the tax, you can see that workers and firms share the tax burden. This division of the tax burden between workers and firms does not depend on whether the government levies the tax on workers, levies the tax on firms, or divides the tax equally between the two groups.
27 Taxes Elasticity and tax incidence Dividing the tax burden Very elastic supply and relatively inelastic demandSellers – small burden of taxBuyers – most of the burdenRelatively inelastic supply and very elastic demandSellers – most of the tax burdenBuyers – small burden
28 How the burden of a tax is divided (a) 9How the burden of a tax is divided (a)(a) Elastic Supply, Inelastic DemandPrice1. When supply is more elastic than demand . . .DemandSupplyPrice buyers payTaxThe incidence of the tax falls more heavily on consumers . . .Price without taxPrice sellersreceiveThan on producers.QuantityIn panel (a), the supply curve is elastic, and the demand curve is inelastic. In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially. Thus, buyers bear most of the burden of the tax.
29 How the burden of a tax is divided (b) 9How the burden of a tax is divided (b)(b) Inelastic Supply, Elastic DemandPrice1. When demand is more elastic than supply . . .DemandSupplyPrice buyers payTax3. Than on consumersPrice without taxThe incidence of the tax falls more heavily on producers.Price sellersreceiveQuantityIn panel (b), the supply curve is inelastic, and the demand curve is elastic. In this case, the price received by sellers falls substantially, while the price paid by buyers rises only slightly. Thus, sellers bear most of the burden of the tax.
30 TaxesTax burden - falls more heavily on the side of the market that is less elasticSmall elasticity of demandBuyers do not have good alternatives to consuming this goodSmall elasticity of supplySellers do not have good alternatives to producing this good
31 1993 – most of the luxury tax – repealed Who pays the luxury tax?new luxury taxGoal: to raise revenue from those who could most easily afford to payLuxury itemsDemand - quite elasticSupply - relatively inelasticOutcome:Burden of a tax falls largely on the suppliers1993 – most of the luxury tax – repealed