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CHAPTER
6
Supply, Demand, and
Government Policies
Economics
P RINCIP LES OF
N. Gregory Mankiw
Premium PowerPoint Slides
by Ron Cronovich
© 2009 South-Western, a part of Cengage Learning, all rights reserved
In this chapter,
look for the answers to these questions:
§ What are price ceilings and price floors?
What are some examples of each?
§ How do price ceilings and price floors affect
market outcomes?
§ How do taxes affect market outcomes?
How do the effects depend on whether
the tax is imposed on buyers or sellers?
§ What is the incidence of a tax?
What determines the incidence?
1
Government Policies That Alter the
Private Market Outcome
§ Price controls
§ Price ceiling:
§ Price floor:
§ 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 eq’m quantity).
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
2
1
EXAMPLE 1: The Market for Apartments
P
Rental
price of
apts
S
$800
Eq’m
Eq’m w/o
w/o
price
price
controls
controls
D
300
Q
Quantity of
apartments
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
A price ceiling
above the
eq’m price
P
S
$800
D
300
Q
4
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
The eq’m price
($800) is
P
S
$800
The ceiling
is a
D
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
5
2
How Price Ceilings Affect Market Outcomes
In the long run,
supply and
demand
are more
price-elastic.
P
S
$800
D
Q
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Shortages and Rationing
§ With a shortage, sellers must ration the goods
among buyers.
§ Some rationing mechanisms:
§ These mechanisms are often unfair, and
inefficient:
§ In contrast, when prices are not controlled,
the rationing mechanism is
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
EXAMPLE 2: The Market for Unskilled Labor
Wage
paid to
unskilled
workers
W
S
$4
Eq’m
Eq’m w/o
w/o
price
price
controls
controls
D
500
L
Quantity of
unskilled workers
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
8
3
How Price Floors Affect Market Outcomes
A price floor
below the
eq’m price
W
S
$4
D
500
L
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes
The eq’m wage ($4)
is
W
S
$4
The floor is
D
L
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The Minimum Wage
Min wage laws
do not affect
highly skilled
workers.
They do affect
teen workers.
W
S
$4
Studies:
D
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
L
11
4
ACTIVE LEARNING 1
Price controls
P
140
Determine
effects of:
A. $90 price
ceiling
The market for
hotel rooms
130
S
120
110
100
90
B. $90 price
floor
80
C. $120 price
floor
60
D
70
50
40
0
Q
50 60 70 80 90 100 110 120 130
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ACTIVE LEARNING 1
A. $90 price ceiling
P
140
The market for
hotel rooms
130
S
120
110
100
90
D
80
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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ACTIVE LEARNING 1
B. $90 price floor
P
140
130
The market for
hotel rooms
S
120
110
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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ACTIVE LEARNING 1
C. $120 price floor
P
140
The market for
hotel rooms
130
S
120
110
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 from Chapter 1:
Markets are usually a good way
to organize economic activity.
§
§ Price controls often intended to help the poor,
but often hurt more than help.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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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 % of the good’s price,
or a specific amount for each unit sold.
§ For simplicity, we analyze per-unit taxes only.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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EXAMPLE 3: The Market for Pizza
Eq’m
Eq’m
w/o
w/o tax
tax
P
S1
$10.00
D1
Q
500
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A Tax on Buyers
The price buyers pay
is now $1.50 higher than
the market price P.
Effects of a $1.50 per
unit tax on buyers
P
S1
$10.00
D1
E.g., if P falls
from $10.00 to $8.50,
buyers still willing to
purchase 500 pizzas.
Q
500
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A Tax on Buyers
Effects of a $1.50 per
unit tax on buyers
New eq’m:
Q=
P
S1
$10.00
D1
500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
20
7
The Incidence of a Tax:
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A Tax on Sellers
Effects of a $1.50 per
unit tax on sellers
P
Sellers will supply
500 pizzas
only if
S1
$10.00
D1
Q
500
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A Tax on Sellers
Effects of a $1.50 per
unit tax on sellers
New eq’m:
Q=
P
S1
$10.00
D1
500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
23
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The Outcome
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
ACTIVE LEARNING 2
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
The market for
hotel rooms
130
S
120
110
100
90
D
80
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
ACTIVE LEARNING 2
Answers
P
140
130
The market for
hotel rooms
S
120
110
100
90
80
Incidence
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
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Elasticity and Tax Incidence
CASE 1: Supply is more elastic than demand
P
S
Price if no tax
D
Q
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Elasticity and Tax Incidence
CASE 2: Demand is more elastic than supply
P
S
Price if no tax
D
Q
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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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: raise revenue from those
who could most easily afford to pay –
wealthy consumers.
§ But who really pays this tax?
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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10
CASE STUDY: Who Pays the Luxury Tax?
The market for yachts
P
Demand
Demand is
is
price-elastic.
price-elastic.
S
In
In the
the short
short run,
run,
supply
supply is
is inelastic.
inelastic.
D
Q
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
30
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
§ Example 2: A binding minimum wage causes
§ So, it’s important for policymakers to apply such
policies very carefully.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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