Presentation is loading. Please wait.

Presentation is loading. Please wait.

G OVERNMENT P OLICIES Economics 101. W HY GOVERNMENT POLICIES ? In a free, unregulated market system, market forces establish equilibrium prices and exchange.

Similar presentations


Presentation on theme: "G OVERNMENT P OLICIES Economics 101. W HY GOVERNMENT POLICIES ? In a free, unregulated market system, market forces establish equilibrium prices and exchange."— Presentation transcript:

1 G OVERNMENT P OLICIES Economics 101

2 W HY 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 is satisfied. One of the roles of economists is to use their theories to assist in the development of policies.

3 C ONTROLS ON P RICES Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Result in government-created price ceilings and floors.

4 P RICE C EILING AND P RICE F LOOR Price Ceiling A legal maximum on the price at which a good can be sold. Price Floor A legal minimum on the price at which a good can be sold.

5 B INDING P RICE C EILING ? Two 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. Sellers must ration the scarce goods The rationing mechanisms – not desirable

6 (a) A Price Ceiling That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity $4 Price ceiling Equilibrium price Demand Supply 3 100

7 Copyright©2003 Southwestern/Thomson Learning (b) A Price Ceiling That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply 2Price ceiling Shortage 75 Quantity supplied 125 Quantity demanded Equilibrium price $3

8 B INDING P RICE C EILING A binding price ceiling creates shortages because Q D > Q S. Example: Gasoline shortage of the 1970s nonprice rationing Examples: Long lines, discrimination by sellers

9 C ASE : L INES AT THE G AS P UMP 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?

10 Copyright©2003 Southwestern/Thomson Learning (a) The Price Ceiling on Gasoline Is Not Binding Quantity of Gasoline 0 Price of Gasoline 1. Initially, the price ceiling is not binding... Price ceiling Demand Supply,S1S1 P1P1 Q1Q1

11 Copyright©2003 Southwestern/Thomson Learning (b) The Price Ceiling on Gasoline Is Binding Quantity of Gasoline 0 Price of Gasoline Demand S1S1 S2S2 Price ceiling QSQS resulting in a shortage the price ceiling becomes binding but when supply falls... P2P2 QDQD P1P1 Q1Q1

12 C ASE : R ENT C ONTROL 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.

13 Copyright©2003 Southwestern/Thomson Learning (a) Rent Control in the Short Run (supply and demand are inelastic) Quantity of Apartments 0 Supply Controlled rent Rental Price of Apartment Demand Shortage

14 Copyright©2003 Southwestern/Thomson Learning (b) Rent Control in the Long Run (supply and demand are elastic) 0 Rental Price of Apartment Quantity of Apartments Demand Supply Controlled rent Shortage

15 B INDING P RICE F LOOR ? 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.

16 F IGURE 4 A M ARKET WITH A P RICE F LOOR Copyright©2003 Southwestern/Thomson Learning (a) A Price Floor That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity 2 Price floor Equilibrium price Demand Supply $3 100

17 F IGURE 4 A M ARKET WITH A P RICE F LOOR Copyright©2003 Southwestern/Thomson Learning (b) A Price Floor That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply $4 Price floor 80 Quantity demanded 120 Quantity supplied Equilibrium price Surplus 3

18 B INDING P RICE F LOOR A binding price floor causes... a surplus because Q S > Q D. nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. Examples: The minimum wage, agricultural price supports

19 C ASE : M INIMUM W AGE 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.

20 F IGURE 5 H OW THE M INIMUM W AGE A FFECTS THE L ABOR M ARKET Copyright©2003 Southwestern/Thomson Learning Quantity of Labor Wage 0 Labor demand Labor Supply Equilibrium employment Equilibrium wage

21 F IGURE 5 H OW THE M INIMUM W AGE A FFECTS THE L ABOR M ARKET Copyright©2003 Southwestern/Thomson Learning Quantity of Labor Wage 0 Labor Supply Labor surplus (unemployment) Labor demand Minimum wage Quantity demanded Quantity supplied

22 T AXES Governments levy taxes to raise revenue for public projects. Taxes discourage market activity. When a good is taxed (commodity tax), the quantity sold is smaller. Buyers and sellers share the tax burden.

23 T AX I NCIDENCE Tax incidence is the manner in which the burden of a tax is shared among participants in a market. Tax incidence is the study of who bears the burden of a tax. _ Statutory incidence (legal incidence) _ Economic incidence

24 C OMMODITY T AX Sale Tax Excise Tax

25 S ALE T AX Sale Tax: a tax on buyer (statutory incidence) Example: USA Case: $0.50 tax per ice-cream cone bought.

26 F IGURE 6 A T AX ON B UYERS Copyright©2003 Southwestern/Thomson Learning Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium without tax Tax ($0.50) Price buyers pay D1D1 D2D2 Supply,S1S1 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). $ Equilibrium with tax

27 W HO ACTUALLY BEARS THE TAX BURDEN ? Buyers and sellers share the tax burden. (economic incidence) In this example, buyers share $0.30 and sellers share $0.20.

28 E XCISE T AX Excise Tax: A Tax on Seller (Statutory incidence) Example: Taiwan Case: $0.50 tax per ice-cream cone sold

29 F IGURE 7 A T AX ON S ELLERS Copyright©2003 Southwestern/Thomson Learning 2.80 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium with tax Equilibrium without tax Tax ($0.50) Price buyers pay S1S1 S2S2 Demand,D1D1 A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50) $

30 W HO ACTUALLY BEARS THE TAX BURDEN ? Buyers and sellers share the tax burden. (economic incidence) In this example, buyers share $0.30 and sellers share $0.20.

31 E LASTICITY AND T AX I NCIDENCE In 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.

32 F IGURE 9 H OW THE B URDEN OF A T AX I S D IVIDED Copyright©2003 Southwestern/Thomson Learning Quantity 0 Price Demand Supply Tax Price sellers receive Price buyers pay (a) Elastic Supply, Inelastic Demand the incidence of the tax falls more heavily on consumers When supply is more elastic than demand... Price without tax than on producers.

33 F IGURE 9 H OW THE B URDEN OF A T AX I S D IVIDED Copyright©2003 Southwestern/Thomson Learning Quantity 0 Price Demand Supply Tax Price sellers receive Price buyers pay (b) Inelastic Supply, Elastic Demand than on consumers. 1. When demand is more elastic than supply... Price without tax the incidence of the tax falls more heavily on producers...

34 S O, 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.

35 ALGEBRA Demand equation: P=10-Qd Supply equation: P=Qs Demand = Supply 10-Q*=Q*, Q*=5; P*=5 Equilibrium quantity=5, equilibrium price=5

36 CASE 1: TAX ON SELLER $2/UNIT SOLD Demand equation: P=10-Qd New supply equation: P-2=Qs Demand = New supply 10-Q**=2+Q**, Q**=4, P**=6 (buyer price), P**- 2=4 (seller price) Buyer shares $1 tax burden Seller shares $1 tax burden

37 CASE 2: TAX ON BUYER $2/UNIT BOUGHT New Demand equation: P+2=10-Qd Supply equation: P=Qs New Demand = Supply 8-Q***=Q***, Q***=4, P***=4 (seller price), P***+2=6 (buyer price) Buyer shares $1 tax burden Seller shares $1 tax burden

38 Q UIZ Demand is perfectly inelastic and supply is elastic 1. Tax on buyers (sales tax) 2. Tax on sellers (excise tax)

39 Q UIZ Supply is perfectly inelastic and demand is elastic 1. Tax on buyers (sales tax) 2. Tax on sellers (excise tax)


Download ppt "G OVERNMENT P OLICIES Economics 101. W HY GOVERNMENT POLICIES ? In a free, unregulated market system, market forces establish equilibrium prices and exchange."

Similar presentations


Ads by Google