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6
Supply, Demand, and
Government Policies
In this chapter, look for the answers to
these questions:
What are price ceilings and price floors?
What are some examples of each?
PRINCIPLES OF
ECONOMICS
How do price ceilings and price floors affect
market outcomes?
FOURTH EDITION
How do taxes affect market outcomes?
How does the outcome depend on whether
the tax is imposed on buyers or sellers?
N. G R E G O R Y M A N K I W
Premium PowerPoint® Slides
by Ron Cronovich
2008 update
Modified by Joseph Tao-yi Wang
What is the incidence of a tax?
What determines the incidence?
CHAPTER 6
© 2008 South-Western, a part of Cengage Learning, all rights reserved
Government Policies That Alter the
Private Market Outcome
EXAMPLE 1: The Market for Apartments
Price controls
•
•
Rental
price of
apts
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.
D
We
We will
will use
use the
the supply/demand
supply/demand model
model to
to see
see
how
how each
each policy
policy affects
affects the
the market
market outcome
outcome
(the
(the price
price buyers
buyers pay,
pay, the
the price
price sellers
sellers receive,
receive,
and
eq’
’m quantity).
eq
and
eq’m
quantity).
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
300
2
Price
ceiling
$8000
D
300
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
How Price Ceilings Affect Market Outcomes
The ceiling
is a binding
constraint
on the price,
causes a
shortage.
Q
4
3
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The eq’m price
($8000) is
above the
ceiling and
therefore illegal.
S
$10000
Q
Quantity of
apartments
How Price Ceilings Affect Market Outcomes
P
S
$8000
The govt can make buyers or sellers pay a
specific amount on each unit bought/sold.
A price ceiling
above the
eq’m price is
not binding –
has no effect
on the market
outcome.
P
Eq’m
Eq’m w/o
w/o
price
price
controls
controls
Taxes
•
1
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
P
S
$8000
Price
ceiling
$5000
shortage
D
250
400
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
5
Shortages and Rationing
How Price Ceilings Affect Market Outcomes
In the long run,
supply and
demand
are more
price-elastic.
So, the
shortage
is larger.
P
among buyers.
Some rationing mechanisms: (1) long lines
(2) discrimination according to sellers’ biases
$8000
Price
ceiling
$5000
shortage
D
Q
450
150
CHAPTER 6
With a shortage, sellers must ration the goods
S
the rationing mechanism is efficient (the goods
go to the buyers that value them most highly)
and impersonal (and thus fair).
EXAMPLE 2: Wages of Gov’tal Employee
Wage of
gov’t
employee
W
CHAPTER 6
20000
D
500
7
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
How Price Floors Affect Market Outcomes
A price floor
below the
eq’m price is
not binding –
has no effect
on the market
outcome.
S
Eq’m
Eq’m w/o
w/o
price
price
controls
controls
the goods do not necessarily go to the buyers who
value them most highly.
In contrast, when prices are not controlled,
6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
These mechanisms are often unfair, and inefficient:
W
S
20000
Price
floor
16000
D
L
500
L
Quantity of gov’t
employee
CHAPTER 6
8
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
How Price Floors Affect Market Outcomes
The eq’m wage
($20,000) is
below the floor
and therefore
illegal.
The floor
is a binding
constraint
on the wage,
causes a
surplus (i.e.,
unemployment).
CHAPTER 6
W
labor
surplus S
The Minimum Wage
Min wage laws
do not affect
highly skilled
workers.
Price
floor
30000
9
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
W
unemployment S
Min.
wage
30000
They do affect
20000
unskilled workers
(like secretaries).
20000
D
400
550
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
What is the form
of unemployment
for governmental
employees in
Taiwan?
L
10
CHAPTER 6
D
400
550
L
Everyone takes the exams!
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
11
ACTIVE LEARNING
Price floors
& ceilings
1:
ACTIVE LEARNING
The market for
hotel rooms
P
140
130
Determine
effects of:
110
100
B. $90 price
floor
80
C. $120 price
floor
S
120
A. $90 price
ceiling
1:
A. $90 price ceiling
90
D
70
60
50
The market for
hotel rooms
P
140
The price
falls to $90.
Buyers
demand
120 rooms,
sellers supply
90, leaving a
shortage.
40
0
Q
50 60 70 80 90 100 110 120 130
S
130
120
110
100
90
Price ceiling
D
80
shortage = 30
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
12
ACTIVE LEARNING
1:
B. $90 price floor
Eq’m price is
above the floor,
so floor is not
binding.
130
P = $100,
Q = 100 rooms.
90
ACTIVE LEARNING
The market for
hotel rooms
P
140
S
110
100
Price floor
1:
C. $120 price floor
120
80
13
D
70
60
P
140
The price
rises to $120.
130
Buyers
demand
60 rooms,
sellers supply
120, causing
a surplus.
110
120
The market for
hotel rooms
surplus = 60
S
Price floor
100
90
80
D
70
60
50
50
40
0
Q
50 60 70 80 90 100 110 120 130
40
0
Q
50 60 70 80 90 100 110 120 130
14
15
Evaluating Price Controls
Taxes
The govt levies taxes on many goods & services
Recall one of the Ten Principles:
to raise revenue to pay for national defense,
public schools, etc.
Markets are usually a good way
to organize economic activity.
Prices are the signals that guide the allocation of
The govt can make buyers or sellers pay the tax.
society’s resources. This allocation is altered
when policymakers restrict prices.
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.
Price controls often intended to help the poor,
but often hurt more than help.
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
16
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
17
A Tax on Buyers
EXAMPLE 3: The Market for Pizza
Eq’m
Eq’m
w/o
w/o tax
tax
A
A tax
tax on
on
buyers
buyers shifts
shifts
the
the D
D curve
curve
down
down by
by the
the
amount
amount of
of
the
the tax.
tax.
P
S1
$300
D1
Q
500
CHAPTER 6
18
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
CHAPTER 6
S1
Tax
$300
PS = $285
D1
D2
Q
430 500
CHAPTER 6
20
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The Outcome Is the Same in Both Cases!
CHAPTER 6
Tax
$300
PS = $285
D1
D2
Q
430 500
19
S1
Tax
D1
430 500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Effects of a $45 per
unit tax on sellers
P
PB =
The
The price
price
buyers
buyers pay
pay
rises,
rises, the
the
price
price sellers
sellers
receive
receive falls,
falls,
eq’m
eq’m Q
Q falls.
falls.
CHAPTER 6
Q
S2
S1
$330
Tax
$300
PS = $285
D1
430 500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
ACTIVE LEARNING
Effects of a tax
The effects on P and Q, and the tax incidence are the
same whether the tax is imposed on buyers or sellers!
P
What matters
is this:
PB = $330
A tax drives
$300
a wedge
PS = $285
between the
price buyers
pay and the
price sellers
receive.
S1
$330
A Tax on Sellers
P
$330
PB =
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A
A tax
tax on
on
sellers
sellers shifts
shifts
the
the S
S curve
curve
up
up by
by the
the
amount
amount of
of
the
the tax.
tax.
how the burden of a tax is shared among
market participants
PB =
P
The
The price
price
buyers
buyers pay
pay
rises,
rises, the
the
price
price sellers
sellers
receive
receive falls,
falls,
eq’m
eq’m Q
Q falls.
falls.
The Incidence of a Tax:
Because
Because
of
of the
the tax,
tax,
buyers
buyers pay
pay
$30
$30 more,
more,
sellers
sellers get
get
$15
$15 less.
less.
Effects of a $45 per
unit tax on buyers
P
140
Suppose govt
imposes a tax
on buyers of
$30 per room.
130
Find new
Q, PB, PS,
and incidence
of tax.
90
Q
21
2:
The market for
hotel rooms
S
120
110
100
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
22
23
ACTIVE LEARNING
Answers
P
140
2:
The market for
hotel rooms
130
Q = 80
Elasticity and Tax Incidence
S
CASE 1: Supply is more elastic than demand
PB = 110
100
PB = $110
90
PS = $80
Buyers’ share
of tax burden
Tax
D
PS = 80
70
Incidence
buyers: $10
sellers: $20
PB
Tax
Price if no tax
Sellers’ share
of tax burden
60
PS
50
D
Elasticity and Tax Incidence
PB
Price if no tax
Sellers’ share
of tax burden
Tax
PS
Sellers
Sellers bear
bear
most
most of
of the
the
burden
burden of
of
the
the tax.
tax.
D
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
25
Who Pays the Cigarette Tax?
2006: Taiwan’s Legislative Yuan increased the
It’s
It’s easier
easier for
for
buyers
buyers than
than
sellers
sellers to
to
leave
leave the
the
market.
market.
S
CHAPTER 6
CASE STUDY:
CASE 2: Demand is more elastic than supply
P
So
So buyers
buyers
bear
bear most
most of
of
the
the burden
burden of
of
the
the tax.
tax.
Q
40
0
Q
50 60 70 80 90 100 110 120 130
24
Buyers’ share
of tax burden
It’s
It’s easier
easier for
for
sellers
sellers than
than
S buyers
buyers to
to leave
leave
the
the market.
market.
P
120
cigarette tax by $5.
Possible “goal” of the tax: to raise revenue from
those who profit from harming other’s health –
“evil” cigarette companies.
But who really pays this tax?
Q
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
The market for Cigarettes
Buyers’ share
of tax burden
supply
supply is
is elastic.
elastic.
Tax
Hence,
Hence,
addicted
addicted
smokers
smokers
pay
pay most
most
of
of the
the tax.
tax.
PS
D
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
• 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
Q
CHAPTER 6
27
allocation of society’s resources.
S In
In the
the short
short run,
run,
PB
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
the Allocation of Resources
Each of the policies in this chapter affects the
Demand
Demand is
is
inelastic.
inelastic.
P
CHAPTER 6
CONCLUSION: Government Policies and
Who Pays the Cigarett Tax?
CASE STUDY:
Sellers’ share
of tax burden
26
policies very carefully.
28
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
29
CHAPTER SUMMARY
CHAPTER SUMMARY
A tax on a good places a wedge between the
A price ceiling is a legal maximum on the price of
price buyers pay and the price sellers receive,
and causes the eq’m quantity to fall, whether the
tax is imposed on buyers or sellers.
a good. An example is rent control. If the price
ceiling is below the eq’m price, it is binding and
causes a shortage.
A price floor is a legal minimum on the price of a
The incidence of a tax is the division of the
good. An example is the minimum wage. If the
price floor is above the eq’m price, it is binding
and causes a surplus. The labor surplus caused
by the minimum wage is unemployment.
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.
CHAPTER 6
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
30
CHAPTER 6
Price Control and Taxation
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Demand and Supply
Supply, Demand and Equilibrium
• Markets are “good”?
• Price control is “bad”!
140
120
100
80
Price
• Homework: Mankiw, Ch. 6, pp.132-134,
Problem 2, 7, 11
Demand
Supply 2
60
40
20
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15
Quantity
Demand and Supply with Tax
Supply, Demand and Equilibrium
160
140
120
Price
100
Demand
80
Tax Supply
Supply 2
60
40
20
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15
Quantity
Bids and Asks (no restrictions)`
31
Unbinding/Binding Price Ceiling
and Binding Price Floor
Taxing the Consumer/Firm
Original: 60, 70, 60, 60, 60,40, 60
New: 70, 80, 70, 70, 80 | 80, 80, 70, 90
Supply, Demand and Equilibrium
Supply, Demand and Equilibrium
140
140
120
120
100
100
80
Demand
Supply 1
Demand
Price
Price
80
Supply 1
60
60
40
40
20
20
Supply 2
0
0
1
2
3
4
5
6
7
8
9
1
10
2
3
4
5
6
7
8
9
10
Quantity
Quantity
Price Controls
Taxing Producers
Supply, Demand and Equilibrium
Supply, Demand and Equilibrium
140
160
120
140
120
100
100
Demand
Supply 2
Price
Price
80
Demand
80
Tax Supply
Supply 2
60
60
40
40
20
20
0
0
1
2
3
4
5
6
Quantity
7
8
9
10
1
2
3
4
5
6
Quantity
7
8
9
10
Taxing Consumers
Supply, Demand and Equilibrium
140
120
100
80
Price
Demand
Tax Demand
Supply 2
60
40
20
0
1
2
3
4
5
6
Quantity
7
8
9
10