1. Governmental Policy and Supply and Demand

2. Price Controls Price Ceilings – Highest legal price of a product or good – Binding if below market equilibrium Leads to shortage – Non-binding if above Price Floor – Lowest legal price of a product or good – Binding if above market equilibrium Leads to surplus – Non-binding if below

3. Price Ceilings D S P Q D S P Q Shortage S*D* No Effect P^

4. Examples: Caution-Using a Model OPEC limits output, US govt places price ceiling on gas – Led to shortage, long lines for gas – Unexpected side effect : small cars boom NY rent control – Short run (inelastic) vs Long run (more elastic) SR small shortage, LR large shortage – Other ways around Key deposits, paying finders fees – Other adverse effects People less likely to move, inefficient Lower quality housing (less incentive to keep up)

5. Price Floors D S P Q D S P Q Surplus S*D* No Effect P_

6. Example: Caution-Using a Model Minimum Wage – 1938 Fair Labor Standards Act Market – Workers Supply Labor (elastic/inelastic ?) – Employers Demand Labor (elastic/inelastic ?) Impact – Above equilibrium: surplus (unemployment) – Higher wages for those with jobs Difference by skills – Skilled Workers unaffected – why? – Unskilled/youth affected – why?

7. Subsidies and Taxes Subsidy: get paid to buy or get paid to produce/sell – Give incentive to participate in market – Market increases in size Tax: have to pay to buy or have to pay to produce/sell – Give disincentive to participate in market – Market decreases in size For both change in market size depends on combined elasticity of supply demand – More elastic bigger change

8. Subsidy Regardless of subsidize buyer or seller – Outcome quantity is the same – Realized buyer/seller price the same – Market price differs by subsidy (also buyer/seller) Both Gain, but: Who gains the most from the subsidy (seller or buyer) depends on whos curve is most inelastic

9. P P QQ Subsidy DD SP=P BP=P-S Q P P QQ Subsidy D SP=P+S BP=P Q S SS Buyer Gets SubsidySeller Gets Subsidy Outcome P, Q, BP, SP (why shift curves up/down?)

10. Subsidy Wedge P SP BP D S SS D D D Subsidy Wedge View Buyer Gets Subsidy View Seller Gets Subsidy View QQQQQQ

11. P D DD S D S BP SP Supply Curve More Inelastic so Seller Gains More Demand Curve More Inelastic so Buyer Gains More Who Gains? : Price Effect

12. S D D S D D QQQQ Very Inelastic So Small Change In Quantity Very Elastic So Large Change In Quantity Effect on Size of Market

13. Winners/Losers Winners – Buyers in market – Sellers in market Losers – Tax payers not in market – Competitors (trading partners)

14. Examples Farm Subsidies – Who wins/loses – Rational Home Buying Subsidies (2 kinds) – Who wins/loses – Rational Ethanol Subsidies – Who wins/loses – Rational

15. Taxes Regardless of taxing buyer or seller – Outcome quantity is the same – Realized buyer/seller price the same – Market price differs by tax (also buyer/seller) Both Lose, but: Who loses the most from the tax (seller or buyer) depends on whos curve is most inelastic – Tax incident

16. P QQ Tax DD P SP=P Q P P QQ Tax D SP=P-T BP=P Q S SS Buyer Gets TaxedSeller Gets Taxed Outcome P, Q, BP, SP (why shift curve down/up?) BP=P+T

17. P D D D S D S BP SP Supply Curve More Inelastic so Seller Loses More Demand Curve More Inelastic so Buyer Loses More Who Loses? : Price Effect P Tax

18. S D D S D D QQQQ Very Inelastic So Small Change In Quantity Very Elastic So Large Change In Quantity Effect on Size of Market

19. Winners/Losers Losers – Buyers in market – Sellers in market Winners – Recipients of the tax money – Competitors (trading partners)

20. Examples Payroll Tax – good is labor supplied by workers demanded by firms – Employee and employer both pay half True Tax incidence – Depends on elasticity of supply(workers) and demand(firms) Change in market size – Depends if markets are elastic or inelastic

21. Example 2 Luxury tax introduced in 1990 to tax those that can most afford to splurge – Luxury demand is elastic – Supply relatively inelastic Outcome – Most of tax incidence fell on suppliers – So repealed in 1992

22. Main Points – Subsidies/Taxes Tax or subsidy creates new hypothetical supply/demand curve – Same outcome if put on seller or buyer Subsidies increase market, taxes reduce it – How much depends how elastic market is Gain or lose from subsidy/tax split between buyers and sellers – Who gets more or pays more depends on who is more inelastic Difference between buyer/seller price is the tax or subsidy size

23. Tax Wedge Buyer share of tax Seller share of tax Tax and its incidence Subsidy Wedge Seller share of subsidy Buyer share of subsidy PP Subsidy and its incidence Review of Graphs (Note whose on top switches)