Download Price Floor - Econ101-s13-Horn

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TAXES
• The govt. levies taxes on many goods &
services to raise revenue to pay for public
services such as national defense and public
schools.
• The tax can be a % of the good’s price,
or a specific amount for each unit sold.
– For simplicity, we analyze per-unit taxes only.
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Market for Coffee
Consider a $6 tax on suppliers
Price
20
S2
18
16
14
Tax
12
S1
10
8
6
4
2
0
0
1
2
3
4
5
6
7
8
9
10
Quantity '000 pounds
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Results of Tax?
• Result 1: Quantity
– Quantity demanded declines – new Q = 4
• Result 2: Price
– Wedge in price, Pc > Ps
– Price paid by consumers increases
– Price received by suppliers decreases
• Result 3: Tax Revenues
– Wedge between price paid by consumers and
received by suppliers is the tax revenue
© 2011 Thomson South-Western
Market for Coffee
Consider a $6 tax on suppliers
Price
20
S2
18
16
14
Tax
12
10
S1
Tax Revenue
8
6
4
2
0
0
1
2
3
4
5
6
7
8
9
10
Quantity '000 pounds
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Results of Tax?
• Result 4: Who pays the tax?
– Consumers pay?
• Pc – P* = $12-$8 = $4
– Producers pay?
• P* – Ps = $8 - $6 = $2
– Even though tax is levied on suppliers, consumers
are paying more of the tax!
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Market for Coffee
Consider a $6 tax on consumers (ex/retail tax)
Price
20
18
16
D1
14
D2
12
10
8
Tax
6
4
2
0
0
1
2
3
4
5
6
7
8
9
10
Quantity '000 pounds
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Results of Tax are the Same!
• Result 1: Quantity
– Quantity demanded declines – new Q = 4
• Result 2: Price
– Wedge in price, Pc > Ps
• Result 3: Tax Revenues
– Revenues are the same
• Result 4: Who pays the tax?
– Consumers pay $12-$8 = $4
– Producers pay $8 - $6 = $2
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Who really pays the tax? What does it
depend on?
Scenario 1: Yachts
Stax
Scenario 2: Cigarettes
Stax
S
S
Pwithout tax
Supplier pays
most of the tax!
Consumer pays
most of the tax!
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Elasticity and Tax Incidence
• More of the tax is borne by the less elastic side
of the market
– Elasticity  Flexibility  Avoid the tax!
• Coffee Tax Example:
– Consumers bear more tax, so consumers must be
more inelastic
| - 1 | < | 1.4 |
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The 2011 payroll tax cut
• Prior to 2011, the Social Security payroll tax was 6.2%
taken from workers’ pay and 6.2% paid by employers
(total 12.4%).
• The Tax Relief Act (2010) reduces the worker’s portion
from 6.2% to 4.2% (for 2011 only), but leaves the
employer’s portion at 6.2%.
QUESTION:
Will the typical worker’s take-home pay rise by exactly
2%, more than 2%, or less than 2%?
Do any elasticities affect your answer? Explain.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2011 Thomson South-Western
Answers
• As long as labor supply and labor demand both
have price elasticity > 0, the tax cut will be shared
by workers and employers, i.e.,
workers’ take-home pay will rise less than 2%.
• The answer does NOT depend on whether labor
demand is more or less elastic than labor supply.
FOLLOW-UP QUESTION:
Who gets the bigger share of this tax cut, workers
or employers? How do elasticities determine the
answer?
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2011 Thomson South-Western
Answers
• If labor demand is more elastic than labor
supply, workers get more of the tax cut than
employers.
• If labor demand is less elastic than labor
supply, employers get the larger share of the
tax cut.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
© 2011 Thomson South-Western
CONTROLS ON PRICES
• Are usually enacted when policymakers
believe the market price is unfair to buyers or
sellers.
• Result in government-created price ceilings
and price floors.
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CONTROLS ON PRICES
• Price Ceiling
– A legal maximum on the price at which a good can
be sold.
– Cannot charge a price higher than this price
• Price Floor
– A legal minimum on the price at which a good can
be sold.
– Price will not fall below this level
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How Price Ceilings Affect Market
Outcomes
• 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.
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Figure 1 A Market with a Price Ceiling
(a) A Price Ceiling That Is Not Binding
Price of
Ice-Cream
Cone
Supply
$4
Price
ceiling
3
The market clears at
$3 and the price
ceiling has no effect.
Equilibrium
price
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
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Figure 1 A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
75
125
Quantity
supplied
Quantity
demanded
Quantity of
Ice-Cream
Cones
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How Price Ceilings Affect Market
Outcomes
• Effects of Price Ceilings
• A binding price ceiling creates
• Shortages because QD > QS.
• Example: Gasoline shortage of the 1970s
• Nonprice rationing
• Examples: Long lines, discrimination by sellers
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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.”
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Figure 3 Rent Control in the Short Run and in the Long Run
(a) Rent Control in the Short Run
(supply and demand are inelastic)
Rental
Price of
Apartment
Supply
Controlled rent
Shortage
Demand
0
Quantity of
Apartments
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Figure 3 Rent Control in the Short Run and in the Long Run
(b) Rent Control in the Long Run
(supply and demand are elastic)
Rental
Price of
Apartment
Supply
Controlled rent
Shortage
0
Demand
Quantity of
Apartments
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How Price Floors Affect Market Outcomes
• 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.
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Figure 4 A Market with a Price Floor
(a) A Price Floor That Is Not Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
The government
says that icecream cones must
sell for at least $2;
this legislation has
no effect at the
current market
price.
Price
floor
2
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
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Figure 4 A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Cone
Supply
Surplus
$4
Price
floor
3
Equilibrium
price
Demand
0
Quantity of
Quantity Quantity Ice-Cream
Cones
demanded supplied
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80
120
How Price Floors Affect Market Outcomes
• A price floor prevents supply and demand from
moving toward the equilibrium price and
quantity.
• When the market price hits the floor, it can fall
no further, and the market price equals the floor
price.
• A binding price floor causes . . .
• a surplus because QS > QD.
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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.
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How Price Floors Affect Market Outcomes
The eq’m wage ($6)
W
is below the floor
$7.25
and therefore
illegal.
$6.00
The floor
is a binding
constraint
on the wage,
causes a
surplus (i.e.,
unemployment).
labor
surplus S
Price
floor
D
400
550
L
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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%.
W
unemployment S
Min.
wage
$7.25
$6.00
D
400
550
L
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ACTIVE LEARNING
Price floors
& ceilings
P
140
130
Determine
effects of:
ceiling
90
C. $120 price
floor
S
110
100
floor
The market for
hotel rooms
120
A. $90 price
B. $90 price
1:
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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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
S
120
100
90
80
Price ceiling
D
shortage = 30
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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ACTIVE LEARNING
B. $90 price floor
Eq’m price is
above the floor,
so floor is not
binding.
P = $100,
Q = 100 rooms.
P
140
1:
The market for
hotel rooms
130
S
120
110
100
90
80
Price floor
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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ACTIVE LEARNING
C. $120 price floor
The price
rises to $120.
Buyers
demand
60 rooms,
sellers supply
120, causing
a surplus.
P
140
130
120
110
1:
The market for
hotel rooms
surplus = 60
S
Price floor
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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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
society’s 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.
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CONCLUSION: Government Policies and the
Allocation of Resources
• Each of the policies in this chapter affects the allocation
of society’s resources.
• Example 1: A tax on pizza reduces eq’m Q.
With less production of pizza, 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, it’s important for policymakers to apply such
policies very carefully.
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