1. Ch. 6: Markets in Action. Price ceiling and inefficiencies.
Price floors (minimum wage) and inefficiency.
Taxes and inefficiencies

2. The effect of price ceilings.
Price ceiling is a maximum price.
“binding” only if ceiling is below equilibrium price.
binding price ceiling causes a shortage.

3. SR & LR effects without price ceiling
Suppose equilibrium price of gasoline is $4 and a hurricane destroys numerous refineries. Examine SR & LR effects on price and quantity. S $4 D

4. Compare outcomes with and without a price ceiling at $4
Shortage
Effect on consumer’s surplus
Effect on producer’s surplus
Deadweight loss
Black markets, search costs, enforcement costs S $4
S-LR D
Millions of gallons per day

5. The effect of price floors
A price floor is a minimum price
binding only if it is set above the equilibrium price
binding price floor creates a surplus.

6. Minimum Wage Is a price floor on labor. Why is there a minimum wage?
Would a higher minimum wage make workers better off?
Efficiency versus equity

7. The Labor Market and the Minimum Wage
Minimum wage is
a price floor.
Price floor is “binding” only if it is above equilibrium price.

8. The Labor Market and the Minimum Wage
A “binding” price floor
reduces consumer (employer) surplus
Could increase or decrease producer (employee) surplus
Creates a deadweight loss
Destroys some of the producer surplus (employee) through search activity.

9. The Effect of Price Floors
In general, a “binding” price floor will result in:
a. Buyers (employers) are worse off
b. Sellers (employees) could be better or worse off.
c. A deadweight loss.

10. Taxes
Tax Incidence
the division of the burden of a tax between the buyer and the seller.
When an item is taxed, its price might rise by the full amount of the tax, by a lesser amount, or not at all.
If the price rises by the full amount of the tax, the buyer pays the tax.
If the price rises by a lesser amount than the tax, the buyer and seller share the burden of the tax.
If the price doesn’t rise at all, the seller pays the tax.

11. Taxes Tax Incidence Tax incidence doesn’t depend on tax law.
The law might impose a tax on the buyer or the seller, but the outcome will be the same.
Example: On July 1, 2002, Mayor Bloomberg upped the cigarette tax in New York City from almost nothing to $1.50 a pack.

12. Tax Incidence .

13. Taxes
Tax incidence:
Buyer: $1
Seller : $.50

14. Taxes A Tax on Buyers Tax incidence:
suppose that buyers, not sellers, are taxed $1.50 a pack.
Tax incidence:
Buyer: $1
Seller: $.50

15. Tax Division and Elasticity of Demand
The more inelastic the demand, the larger is the buyers’ share of the tax.

16. Taxes
The more elastic the supply, the larger is the buyers’ share of the tax.

17. Taxes Taxes in Practice
Taxes usually are levied on goods and services with an inelastic demand or an inelastic supply.
Alcohol, tobacco, and gasoline have inelastic demand, so the buyers of these items pay most of the tax on them.
Labor has a low elasticity of supply, so the seller—the worker—pays most of the income tax and most of the Social Security tax.

18. Taxes
Taxes create allocative inefficiency unless S or D is perfectly inelastic.
What’s effect of tax on
Consumer surplus
Producer surplus
Tax revenue
Deadweight loss
Excess burden of tax
reduction in consumer & producer surplus minus tax revenue
Identical to deadweight loss

19. Subsidies and Quotas
Fluctuations in the weather bring big fluctuations in farm output.
How do changes in farm output affect the prices of farm products and farm revenues?
How might farmers be helped by intervention in markets for farm products?

20. Stabilizing Farm Revenues
A poor harvest decreases supply.
Effect on total revenue?
higher price
lower quantity
How would answer change if demand were elastic?

21. Stabilizing Farm Revenues
A large harvest increases supply.
Effect on total revenue?
Lower price
Higher quantity
How would answer change if demand were elastic?

22. Stabilizing Farm Revenues
Intervention in markets for farm products takes two main forms:
Subsidies
a payment made by the government to a producer that’s in addition to market price received.
Production quotas
an upper limit on the quantity of a good that may be produced during a specified period.

23. Subsidies Effect of $20 subsidy Equilibrium quantity Equilibrium price
Consumer surplus
Producer surplus
Cost to taxpayers
Deadweight loss

24. Quotas Maximum production allowed.
Binding only if below equil quantity
limits total production to 40 million tons a year.
Effect on
Price
Consumer’s surplus
Producer’s surplus
Deadweight loss
Price of license