Download Price Controls and Taxes

Repealing the Laws of
Supply and Demand:
Price Controls
Price Ceiling

A legally established maximum price at which a
good can be sold.
Price Floor

A legally established minimum price at which a
good can be sold.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Not Binding...
Price of
Ice-Cream
Cone
Supply
Price
ceiling
$4
3
Equilibrium
price
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Binding...
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
Price
ceiling
2
Shortage
Demand
0
75
Quantity
supplied
125
Quantity
demanded
Quantity of
Ice-Cream
Cones
The 1970s Energy Crisis:
The Price Ceiling on Gasoline
S2
Price of
Gasoline
2. …but
when supply
falls...
S1
P2
Price
ceiling
P1
3. …the price
ceiling becomes
binding...
4. …resulting
in a shortage.
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Q1
Quantity of
Gasoline
Rent Control in the Short Run...
Rental
Price of
Apartment
Supply
Supply and
demand for
apartments
are relatively
inelastic
Controlled rent
Shortage
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Apartments
Rent Control in the Long Run...
Rental
Price of
Apartment
Because the
supply and
demand for
apartments are
more elastic...
Supply
…rent control
causes a large
shortage
Controlled rent
Shortage
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Apartments
The Minimum Wage: An
important example of a price
floor …
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Free Labor Market
Wage
Labor
supply
Equilibrium
wage
Labor
demand
0
Equilibrium
employment
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Labor
The Minimum Wage
Wage
A Labor Market with a
Minimum Wage
Labor surplus
(unemployment)
Labor
supply
Minimum
wage
Labor
demand
0
Quantity
demanded
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity
supplied
Quantity of
Labor



What are the equilibrium price and quantity of Frisbees?
Frisbee manufacturers persuade the government that Frisbee
production improves scientists’ understanding of aerodynamics
and thus is important for national security. A concerned
Congress votes to impose a price floor $2 above the equilibrium
price. What is the new market price? How many Frisbees are
sold?
Irate college students march on Washington and demand a
reduction in the price of Frisbees. An even more concerned
Congress votes to repeal the price floor and impose a price
ceiling $1 below the former price floor. What is the new market
price? How many Frisbees are sold?
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Taxes
Governments levy taxes to
raise revenue for public
needs.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
What are some potential
impacts of taxes?
Taxes discourage
market activity.
When a good is taxed,
the quantity sold is
smaller.
Buyers and sellers
share the tax burden.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Copyright © 2001 by Harcourt, Inc. All rights reserved
Impact of a 50¢ Tax Levied on
Buyers...
Price of
Ice-Cream
Cone
Supply, S1
3.00
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).
D1
D2
0
100
Quantity of
Ice-Cream Cones
Copyright © 2001 by Harcourt, Inc. All rights reserved
Impact of a 50¢ Tax Levied on
Buyers...
Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax
$3.30
3.00
2.80
Price
sellers
receive
Supply, S1
Equilibrium without tax
Tax ($0.50)
Equilibrium
with tax
D1
D2
0
90 100
Quantity of
Ice-Cream Cones
What was the impact of tax?
 Taxes discourage market
activity.
 When a good is taxed, the
quantity sold is smaller.
 Tax puts a wedge between
the price buyers pay and
the price sellers receive.
 Buyers and sellers share
the tax burden.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Copyright © 2001 by Harcourt, Inc. All rights reserved
Impact of a 50¢ Tax on Sellers...
Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax
$3.30
3.00
2.80
S2
Equilibrium
with tax
S1
Tax ($0.50)
A tax on sellers
shifts the
supply curve
upward by the
amount of the
tax ($0.50).
Equilibrium without tax
Price
sellers
receive
Demand, D1
0
90 100
Quantity of
Ice-Cream Cones
What was the impact of tax?
 Taxes discourage market
activity.
 When a good is taxed, the
quantity sold is smaller.
 Tax puts a wedge between
the price buyers pay and
the price sellers receive.
 Buyers and sellers share
the tax burden.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Elastic Supply, Inelastic Demand...
Price
1. When supply is more
elastic than demand...
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
3. ...than on
producers.
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
2. ...the
incidence of the
tax falls more
heavily on
consumers...
Demand
Quantity
Inelastic Supply, Elastic Demand...
1. When demand is more
elastic than supply...
Price
Supply
Price buyers pay
Price without tax
3. ...than on consumers.
Tax
Price sellers receive
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Demand
2. ...the
incidence of
the tax falls more
heavily on producers...
Quantity
So, how is the burden of the
tax divided?
The
burden of a tax
falls more heavily on
the side of the market
that is less elastic.
If you can’t easily
adjust, you’re stuck
paying most of the tax.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Summary
Price
controls include price ceilings
and price floors.
 A price ceiling is a legal maximum on
the price of a good or service. An
example is rent control.
A price floor is a legal minimum on
the price of a good or a service. An
example is the minimum wage.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Summary
Taxes
are used to raise revenue for
public purposes.
When the government levies a tax on
a good, the equilibrium quantity of
the good falls.
A tax on a good places a wedge
between the price paid by buyers and
the price received by sellers.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Summary
The
incidence of a tax refers to who
bears the burden of a tax.
The incidence of a tax does not
depend on whether the tax is levied
on buyers or sellers.
The incidence of the tax depends on
the price elasticities of supply and
demand.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Graphical
Review
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Not Binding...
Price of
Ice-Cream
Cone
Supply
Price
ceiling
$4
3
Equilibrium
price
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Binding...
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
Price
ceiling
2
Shortage
Demand
0
75
Quantity
supplied
125
Quantity
demanded
Quantity of
Ice-Cream
Cones
The Price Ceiling on Gasoline Is
Not Binding...
Price of
Gasoline
1. Initially,
the
price ceiling
is not
binding...
Supply
Price
ceiling
$4
P1
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Q1
Quantity of
Gasoline
The Price Ceiling on Gasoline Is
Binding...
S2
Price of
Gasoline
2. …but
when supply
falls...
S1
P2
Price
ceiling
P1
3. …the price
ceiling becomes
binding...
4. …resulting
in a shortage.
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Q1
Quantity of
Gasoline
Rent Control in the Short Run...
Rental
Price of
Apartment
Supply
Supply and
demand for
apartments
are relatively
inelastic
Controlled rent
Shortage
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Apartments
Rent Control in the Long Run...
Rental
Price of
Apartment
Because the
supply and
demand for
apartments are
more elastic...
Supply
…rent control
causes a large
shortage
Controlled rent
Shortage
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Apartments
A Price Floor That Is Not Binding...
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
Price
floor
2
Demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Floor That Is Binding...
Price of
Ice-Cream
Cone
Surplus
$4
Supply
Price floor
$3
Equilibrium
price
Demand
0
80
Quantity
demanded
120
Quantity
supplied
Quantity of
Ice-Cream
Cones
The Minimum Wage
Wage
A Free Labor Market
Labor
supply
Equilibrium
wage
Labor
demand
0
Equilibrium
employment
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Labor
The Minimum Wage
Wage
A Labor Market with a
Minimum Wage
Labor surplus
(unemployment)
Labor
supply
Minimum
wage
Labor
demand
0
Quantity
demanded
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity
supplied
Quantity of
Labor
Impact of a 50¢ Tax Levied on
Buyers...
Price of
Ice-Cream
Cone
Supply, S1
3.00
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).
D1
D2
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
100
Quantity of
Ice-Cream Cones
Impact of a 50¢ Tax Levied on
Buyers...
Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax
$3.30
3.00
2.80
Price
sellers
receive
Supply, S1
Equilibrium without tax
Tax ($0.50)
Equilibrium
with tax
D1
D2
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
90 100
Quantity of
Ice-Cream Cones
Impact of a 50¢ Tax on Sellers...
Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax
$3.30
3.00
2.80
S2
Equilibrium
with tax
S1
Tax ($0.50)
A tax on sellers
shifts the
supply curve
upward by the
amount of the
tax ($0.50).
Equilibrium without tax
Price
sellers
receive
Demand, D1
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
90 100
Quantity of
Ice-Cream Cones
A Payroll Tax
Wage
Labor
supply
Wage firms
pay
Wage Tax wedge
without tax
Wage workers
receive
Labor
demand
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Quantity of
Labor
Elastic Supply, Inelastic Demand...
Price
1. When supply is more
elastic than demand...
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
3. ...than on
producers.
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
2. ...the
incidence of the
tax falls more
heavily on
consumers...
Demand
Quantity
Inelastic Supply, Elastic Demand...
1. When demand is more
elastic than supply...
Price
Supply
Price buyers pay
Price without tax
3. ...than on consumers.
Tax
Price sellers receive
0
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Demand
2. ...the
incidence of
the tax falls more
heavily on producers...
Quantity