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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 3 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 6 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 7 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 9 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 10 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 12 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 13 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 14 5 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 15 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 16 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 17 6 EXAMPLE 3: The Market for Pizza Eq’m Eq’m w/o w/o tax tax P S1 $10.00 D1 Q 500 18 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 19 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: 21 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 22 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 8 The Outcome 24 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 9 Elasticity and Tax Incidence CASE 1: Supply is more elastic than demand P S Price if no tax D Q 27 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 28 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 29 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 31 11