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Topic 4 - Supply & Demand & Government Policies PDF

Government policies like price controls and taxes can alter market outcomes from the private market equilibrium. Price ceilings set maximum prices and cause shortages, while price floors set minimum prices and cause surpluses. Taxes drive a wedge between what buyers pay and sellers receive, reducing equilibrium quantity. The incidence of taxes depends on supply and demand elasticities, with inelastic sides bearing more of the burden.

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511 views32 pages

Topic 4 - Supply & Demand & Government Policies PDF

Government policies like price controls and taxes can alter market outcomes from the private market equilibrium. Price ceilings set maximum prices and cause shortages, while price floors set minimum prices and cause surpluses. Taxes drive a wedge between what buyers pay and sellers receive, reducing equilibrium quantity. The incidence of taxes depends on supply and demand elasticities, with inelastic sides bearing more of the burden.

Uploaded by

郑伟权
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Supply & Demand & Government Policies

INTRODUCTION
TO
MICROECONOMICS

Government Policies That Alter the


Private Market Outcome

Price controls

Price ceiling: a legal maximum on the price


of a good or service. Example: rent control.
Price floor: a legal minimum on the price of
a good or service. Example: minimum wage.

Taxes

The govt can make buyers or sellers pay a


specific amount on each unit bought/sold.
We will use the supply/demand model to see
how each policy affects the market outcome
(the price buyers pay, the price sellers receive, and eqm
quantity).
1

EXAMPLE 1: The Market for Apartments


P

Rental
price of
apts

$800

Eqm w/o
price
controls
D
300

Quantity of
apartments
2

How Price Ceilings Affect Market Outcomes


A price ceiling
above the
eqm price is
not binding
it has no effect
on the market
outcome.

S
Price
ceiling

$1000
$800

D
300

How Price Ceilings Affect Market Outcomes


The eqm price
($800) is above
the ceiling and
therefore illegal.

The ceiling
is a binding
constraint
on the price,
and causes
a shortage.

$800
Price
ceiling

$500
shortage
D
250

400

How Price Ceilings Affect Market Outcomes


In the long run,
supply and
demand
are more
price-elastic.

So, the
shortage
is larger.

$800
Price
ceiling

$500
shortage
150

450

D
Q

Shortages and Rationing


With a shortage, sellers must ration the goods
among buyers.

Some rationing mechanisms: (1) long lines


(2) discrimination according to sellers biases

These mechanisms are often unfair, and inefficient:


the goods dont necessarily go to the buyers who
value them most highly.

In contrast, when prices are not controlled,


the rationing mechanism is efficient (the goods
go to the buyers that value them most highly)
and impersonal (and thus fair).
6

EXAMPLE 2: The Market for Unskilled Labor


Wage
paid to
unskilled
workers

$4

Eqm w/o
price
controls
D
500

Quantity of
unskilled workers
7

How Price Floors Affect Market Outcomes


A price floor
below the
eqm price is
not binding
it has no effect
on the market
outcome.

$4
Price
floor

$3
D
500

How Price Floors Affect Market Outcomes


The eqm wage ($4)
is below the floor
and therefore
illegal.
The floor
is a binding
constraint
on the wage,
and causes
a surplus
(i.e.,
unemployment).

labor
surplus S

Price
floor

$5
$4

D
400

550

The Minimum Wage


Min wage laws
do not affect
highly skilled
workers.
They do affect
teen workers.

Studies:
A 10% increase
in the min wage
raises teen
unemployment
by 1-3%.

unemployment S

Min.
wage

$5
$4

D
400

550

10

ACTIVE LEARNING

Price floors
& ceilings

P
140
130

Determine
effects of:

The market for


hotel rooms

120
110

A. $90 price
ceiling

100

B. $90 price
floor

80

C. $120 price
floor

1:

90

70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
11

ACTIVE LEARNING

A. $90 price ceiling


P
140

The price
falls to $90.

130

Buyers
demand
120 rooms,
sellers supply
90, leaving a
shortage.

110

1:
The market for
hotel rooms

120
100
90
80

Price ceiling

shortage = 30

70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
12

ACTIVE LEARNING

B. $90 price floor

P
140

Eqm price is
above the floor,
so floor is not
binding.
P = $100,
Q = 100 rooms.

1:
The market for
hotel rooms

130

120
110
100
90
80

Price floor

70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
13

ACTIVE LEARNING

C. $120 price floor

P
140

The price
rises to $120.

130

Buyers
demand
60 rooms,
sellers supply
120, causing
a surplus.

110

120

1:
The market for
hotel rooms
surplus = 60

Price floor

100
90
80

70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
14

Evaluating Price Controls


Recall one of the Ten Principles:
Markets are usually a good way
to organize economic activity.

Prices are the signals that guide the allocation of


societys resources. This allocation is altered
when policymakers restrict prices.

Price controls are often intended to help the poor,


but they often hurt more than help them:

The min. wage can cause job losses.


Rent control can reduce the quantity and quality
of affordable housing.
15

Taxes
The govt levies taxes on many goods & services
to raise revenue to pay for national defense,
public schools, etc.

The govt can make buyers or sellers pay the tax.


The tax can be a percentage of the goods price,
or a specific amount for each unit sold.
For simplicity, we analyze per-unit taxes only.

16

EXAMPLE 3: The Market for Pizza

Eqm
w/o tax

P
S1
$10.00

D1

500

17

A Tax on Buyers
A tax on
buyers shifts
the D curve
down by the
amount of
the tax.
The price
buyers pay
rises, the
price sellers
receive falls,
eqm Q falls.

Effects of a $1.50 per


unit tax on buyers
P
PB = $11.00

S1
Tax

$10.00
PS = $9.50

D1
D2

430 500

18

The Incidence of a Tax:


how the burden of a tax is shared among
market participants
Because
of the tax,
buyers pay
$1.00 more,
sellers get
$0.50 less.

P
PB = $11.00

S1
Tax

$10.00
PS = $9.50

D1
D2

430 500

19

A Tax on Sellers
A tax on
sellers shifts
the S curve
up by the
amount of
the tax.
The price
buyers pay
rises, the
price sellers
receive falls,
eqm Q falls.

Effects of a $1.50 per


unit tax on sellers
P
PB = $11.00

S2
S1
Tax

$10.00
PS = $9.50

D1

430 500

20

The Outcome Is the Same in Both Cases!


The effects on P and Q, and the tax incidence are the
same whether the tax is imposed on buyers or sellers!
What matters
is this:
A tax drives
a wedge
between the
price buyers
pay and the
price sellers
receive.

P
PB = $11.00

S1
Tax

$10.00
PS = $9.50

D1

430 500

21

ACTIVE LEARNING

Effects of a tax
Suppose govt
imposes a tax
on buyers of
$30 per room.
Find new
Q, PB, PS,
and incidence
of tax.

P
140
130

2:
The market for
hotel rooms

120
110
100
90
80

70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
22

ACTIVE LEARNING

Answers
Q = 80
PB = $110

P
140

120
PB = 110

90
PS = 80

Incidence
buyers: $10
sellers: $20

The market for


hotel rooms

130

100

PS = $80

2:

Tax

70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
23

Elasticity and Tax Incidence


CASE 1: Supply is more elastic than demand
In this case,
buyers bear
most of the
burden of
the tax.

Buyers share
of tax burden

PB

S
Tax

Price if no tax

Sellers share
of tax burden

PS
D
Q
24

Elasticity and Tax Incidence


CASE 2: Demand is more elastic than supply
P

Buyers share
of tax burden

PB

Price if no tax

Sellers share
of tax burden

In this case,
sellers bear
most of the
burden of
the tax.

Tax
PS

D
Q
25

Elasticity and Tax Incidence

If buyers price elasticity > sellers price elasticity,


buyers can more easily leave the market when
the tax is imposed, so buyers will bear a smaller
share of the burden of the tax than sellers.

If sellers price elasticity > buyers price elasticity,


the reverse is true.

26

CASE STUDY: Who Pays the Luxury Tax?

1990: Congress adopted a luxury tax on yachts,


private airplanes, furs, expensive cars, etc.

Goal of the tax: to raise revenue from those


who could most easily afford to pay
wealthy consumers.

But who really pays this tax?

27

CASE STUDY: Who Pays the Luxury Tax?


The market for yachts
P

Buyers share
of tax burden

Demand is
price-elastic.
S

In the short run,


supply is inelastic.

PB

Tax
Sellers share
of tax burden

PS

D
Q

Hence,
companies
that build
yachts pay
most of
the tax.
28

CONCLUSION: Government Policies and

the Allocation of Resources

Each of the policies in this chapter affects the


allocation of societys resources.

Example 1:

a tax on pizza reduces the eqm


quantity of pizza.
Since the economy is producing fewer pizzas,
some resources (workers, ovens, cheese) will
become available to other industries.
Example 2: a binding minimum wage causes a
surplus of workers, a waste of resources.

So, its important for policymakers to apply such


policies very carefully.
29

CHAPTER SUMMARY
A price ceiling is a legal maximum on the price of
a good. An example is rent control. If the price
ceiling is below the eqm price, it is binding and
causes a shortage.

A price floor is a legal minimum on the price of a


good. An example is the minimum wage. If the
price floor is above the eqm price, it is binding
and causes a surplus. The labor surplus caused
by the minimum wage is unemployment.

30

CHAPTER SUMMARY
A tax on a good places a wedge between the
price buyers pay and the price sellers receive,
and causes the eqm quantity to fall, whether the
tax is imposed on buyers or sellers.

The incidence of a tax is the division of the


burden of the tax between buyers and sellers,
and does not depend on whether the tax is
imposed on buyers or sellers.

The incidence of the tax depends on the price


elasticities of supply and demand.
31

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