1 Supply, Demand, and 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.22
2 CONTROLS ON PRICESAre usually enacted when policymakers believe the market price is unfair to buyers or sellers.Result in government-created price ceilings and floors.33
3 CONTROLS ON PRICES Price Ceiling Price Floor A legal maximum on the price at which a good can be sold.Price FloorA legal minimum on the price at which a good can be sold.44
4 Figure 1 A Market with a Price Ceiling (b) A Price Ceiling That Is BindingPrice ofIce-CreamConeSupplyThe price ceiling is binding. It changes the market outcome.DemandEquilibriumprice$32Priceceiling75125ShortageQuantity ofIce-CreamQuantitysuppliedQuantitydemandedCones
5 Figure 1 A Market with a Price Ceiling (a) A Price Ceiling That Is Not BindingPrice ofIce-CreamConeSupplyDemand$4Priceceiling3100EquilibriumpriceThe market clears at $3 and the price ceiling is ineffective.Quantity ofIce-CreamEquilibriumquantityCones
6 How Price Ceilings Affect Market Outcomes Effects of Price CeilingsA binding price ceiling createsShortages because QD > QS.Example: Gasoline shortage of the 1970sNonprice rationingThere are buyers willing to pay a higher price at which sellers willing to supply the market, however market transactions at that price are considered illegal.Examples: Long lines, discrimination by sellers1114
7 CASE STUDY: Binding vs. Non Binding Ceiling 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?Economists blame government regulations that limited the price oil companies could charge for gasoline.
8 The Market for Gasoline with a Price Ceiling (a) The Price Ceiling on Gasoline Is Not BindingPrice ofGasolineDemandSupply,S11. Initially,the priceceilingis notbinding . . .Price ceilingP1Q1Quantity ofGasoline
9 The Market for Gasoline with a Price Ceiling (b) The Price Ceiling on Gasoline Is BindingPrice ofS2Gasolinebut whensupply falls . . .DemandS1P2QSQDPrice ceilingresultingin ashortage.the priceceiling becomesbinding . . .P1Q1Quantity of5 …and a large change in quantityGasoline
10 CASE STUDY: Rent Control in the Short Run and Long Run 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.”2
11 Rent Control in the Short Run and in the Long Run (a) Rent Control in the Short Run(supply and demand are inelastic)RentalPrice ofApartmentSupplyDemandControlled rentShortageQuantity ofApartments
12 Rent Control in the Short Run and in the Long Run (b) Rent Control in the Long Run(supply and demand are elastic)RentalPrice ofApartmentSupplyDemandControlled rentShortageQuantity ofApartments
13 How Price Floors Affect Market Outcomes A price floor prevents supply and demand from moving toward the equilibrium price and quantity.A 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 supports1525
14 A Market with a Price Floor (b) A Price Floor That Is BindingPrice ofIce-CreamSupplyConeDemandSurplus$4Pricefloor801203EquilibriumpriceQuantity ofIce-CreamQuantitydemandedQuantitysuppliedCones
15 A Market with a Price Floor (a) A Price Floor That Is Not BindingPrice ofIce-CreamThe government sets a $2 minimum price for ice cream. The legislation is ineffective .SupplyConeDemandEquilibriumprice$31002PricefloorQuantity ofIce-CreamEquilibriumquantityCones
16 CASE STUDY: 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.
17 Figure 5 How the Minimum Wage Affects the Labor Market SupplyLabordemandEquilibriumemploymentwageQuantity ofLabor
18 Figure 5 How the Minimum Wage Affects the Labor Market SupplyLabordemandLabor surplus(unemployment)MinimumwageQuantitydemandedQuantitysuppliedQuantity ofLabor
19 How the Minimum Wage Affects the Labor Market The minimum wage results in an increase in the quantity supplied of workers and a decline in the quantity demanded.Unemployment results as workers who are willing to work at the min wage are more than the jobs offered
20 Who gets to work at the minimum wage? The answer will determine the distributional impact of the policySeveral researches suggests that employers when faced with a larger labor pool under the minimum wage law, can discriminate between workers.Teenagers tend to be discriminated against due to their limited training and education relative to others in the poolSimilarly for women and minorities.
21 TAXES Governments levy taxes to : raise revenue for public projects Change market price to reduce trade in a particular good2029
22 How Taxes Affect Market Outcomes Tax incidenceTax 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.Taxes result in a change in market equilibrium.2131
23 How Taxes Affect Market Outcomes When a tax is imposed there are two prices of interest:The price that the buyers pay.The price that sellers receive.The difference between the two is the tax.Let’s first consider a tax on buyers.2131
24 Figure 6 A Tax on Buyers Price Price buyers willing to pay before the taxD1D23.00100A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).Tax ($0.50)$2.5Quantity ofIce-Cream Cones
25 Figure 6 A Tax on Buyers Price of Ice-Cream Price buyers pay Supply, ConeD1D2$3.3090Equilibrium without taxTax ($0.50)Pricewithouttax3.00100A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).2.80Equilibriumwith taxPricesellersreceiveQuantity ofIce-Cream Cones
26 Statutory Incidence of the tax How is a tax imposed on the buyer different from that imposed on the seller?
27 Figure 7 A Tax on Sellers Price Price sellers Accept after the tax shifts the supplycurve upwardby the amount ofthe tax ($0.50).S23.50Tax ($0.50)S13.00100PriceSellers acceptbefore the taxQuantity ofIce-Cream Cones
28 Figure 7 A Tax on Sellers Price of Ice-Cream Demand, D1 shifts the supplycurve upwardby the amount ofthe tax ($0.50).PricebuyerspayConeS2S1$3.3090Tax ($0.50)Pricewithouttax3.001002.80PricesellersreceiveQuantity ofIce-Cream Cones
29 How are they different?A $t tax imposed on the buyer has the same effect as a $t tax imposed on the sellersThe price received by the seller is the same.The price paid by the buyer is the same.The tax creates a wedge between the supply and demand curves.The burden of the tax is shared between buyers and sellers.
30 Figure 8 A Payroll Tax Q Price S Price buyers pay Tax wedge Price without taxPrice sellersreceiveQQuantity
31 Elasticity and Tax Incidence 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.2230
32 Elasticity and Tax Incidence 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.2939
33 Figure 9 How the Burden of a Tax Is Divided (a) Elastic Supply, Inelastic DemandPrice1. When supply is more elasticthan demand . . .DemandPrice buyers payTaxtheincidence of thetax falls moreheavily onconsumers . . .SupplyPrice without taxthanon producers.Price sellersreceiveQuantity
34 Figure 9 How the Burden of a Tax Is Divided (b) Inelastic Supply, Elastic DemandPrice1. When demand is more elasticthan supply . . .DemandPrice buyers paySupplyTaxthan onconsumers.Price without taxtheincidence ofthe tax fallsmore heavilyon producers . . .Price sellersreceiveQuantity
35 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.3041