6_Demand Supply Gove Policies

8/8/2019 6_Demand Supply Gove Policies

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Supply, Demand and

Government Policies

Chapter 6

Copyright 2001 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of any part of the

work should be mailed to:

Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.


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Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.

Supply, Demand, and

Government PoliciesIn a free, unregulated market system,

market forces establish equilibrium prices

and exchange quantities.

While equilibrium conditions may be

efficient, it may be true that not everyone is

satisfied.One of the roles of economists is to use their

theories to assist in the development of

policies.


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Price Controls...

Are usually enacted when

policymakers believe the marketprice is unfair to buyers or sellers.

Result in government-created price

ceilings and floors.


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Price Ceilings & Price Floors

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.


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Price Ceilings

Two outcomes are possible when the

government imposes a price ceiling: The price ceiling is notbinding 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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A Price Ceiling That Is Not Binding...

$4

3

Quantity of

Ice-CreamCones

0

Price ofIce-Cream

Cone

Demand

Supply

Priceceiling

Equilibriumprice

100

Equilibriumquantity



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A Price Ceiling That Is Binding...

$3

Quantity ofIce-Cream

Cones

0

Price ofIce-Cream

Cone

2

Demand

Supply

Equilibriumprice

Price

ceilingShortage

125

Quantitydemanded

75

Quantitysupplied



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Effects ofPrice 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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Lines at the Gas PumpIn 1973 OPEC raised the price of

crude oil in world markets. Because

crude oil is the major input used to

make gasoline, the higher oil prices

reduced the supply of gasoline.

What was responsible for the long

gas lines?Economists blame government

regulations that limited the price oil

companies could charge for gasoline.


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The Price Ceiling on Gasoline Is

Not Binding...

$4

P1

Quantity of

Gasoline

0

Price ofGasoline

Q1

Demand

Supply

Priceceiling

1. Initially,theprice ceiling

is notbinding...


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Binding...

P1

Quantity of

Gasoline

0

Price ofGasoline

Q1

Demand

S1

Priceceiling

S2 2. butwhen supplyfalls...

P2

3. the priceceiling becomesbinding...4. resulting

in a shortage.


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Rent Control

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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Rent Control in the ShortRun...

Quantity ofApartments

0

RentalPrice ofApartment

Demand

Supply

Controlled rent

Shortage

Supply anddemand forapartments

are relatively

inelastic


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Rent Control in the LongRun...


0


Demand

Supply

Controlled rent

Shortage

Because thesupply anddemand for

apartments aremore elastic...

rent controlcauses a large

shortage


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Price Floors

When the government imposes a

price floor, two outcomes are

possible.

The price floor is notbinding if set below

the equilibrium price.

The price floor is binding if set above theequilibrium price, leading to a surplus.


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A Price Floor That Is Not Binding...

$3

Quantity of

Ice-CreamCones

0

Price ofIce-Cream

Cone

100

Equilibriumquantity

Equilibriumprice

Demand

Supply

Price

floor2


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A Price Floor That Is Binding...

$3

Quantity of

Ice-CreamCones

0

Price ofIce-Cream

Cone

Equilibriumprice

Demand

Supply

Price floor$4

120

Quantitysupplied

80

Quantitydemanded

Surplus



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Effects o

fa Price Floor

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.


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Effects ofa Price Floor

A binding price floor causes . . .

~ a surplus because QS>QD.

~

nonprice rationing is an alternative

mechanism for rationing the good,

using discrimination criteria.

Examples: The minimum wage, Agricultural

price supports


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The Minimum Wage

An important example of a

price floor is the minimum

wage. Minimum wage lawsdictate the lowest price

possible for labor that any

employer may pay.


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The Minimum Wage

Quantity of

Labor

0

Wage

Equilibriumwage

Labordemand

Laborsupply

A Free Labor Market

Equilibrium

employment


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Minimumwage

The Minimum Wage

Quantity of

Labor

0

Wage

Labordemand

Laborsupply

Quantity

supplied

Quantity

demanded

Labor surplus(unemployment)

A Labor Market with aMinimum Wage


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Taxes

Governments levy taxes toraise revenue for public

projects.


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What are some potential

impacts of taxes?Taxes discourage

market activity.

When a good is taxed,

the quantity sold is

smaller.

Buyers and sellersshare the tax burden.


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Taxes

Tax incidence is the study of who

bears the burden of a tax.

Taxes result in a change in marketequilibrium.

Buyers pay more and sellers receive

less, regardless of whom the tax is

levied on.


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Impact of a 50 Tax Levied on

Buyers...

3.00

Quantity ofIce-Cream Cones0

Price ofIce-Cream

Cone

100

D1

Supply, S1

A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).

D2

Copyright 2001 by Harcourt, Inc. All rights reserved


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3.00


Price ofIce-Cream

Cone

10090

$3.30

Pricebuyers

pay

D1

D2

Equilibrium

with tax

Supply, S1

Equilibrium without tax


Buyers...

2.80

Price

sellersreceive


Pricewithout

tax

Tax ($0.50)


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What was the impact of tax?

Taxes discourage

market activity.

When a good is taxed,

the quantity sold is

smaller.

Buyers and sellersshare the tax burden.


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3.00


Price ofIce-Cream

Cone

10090

S1

S2

Demand, D1

Impact of a 50 Tax on Sellers...

Pricewithout

tax2.80

Price

sellersreceive

$3.30

Pricebuyers

pay



A tax on sellersshifts the

supply curve

upward by theamount of thetax ($0.50).

Tax ($0.50)

Equilibriumwith tax


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A Payroll Tax

Quantity of

Labor

0

Wage

Wagewithout tax

Labordemand

Laborsupply

Tax wedge

Wage firmspay

Wage workersreceive


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The Incidence ofTax

In what proportions is the burden of

the tax divided?

How do the effects of taxes on sellers

compare to those levied on buyers?

The answers to these questions

depend on the elasticity ofdemand

and the elasticity ofsupply.


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Elastic Supply, Inelastic Demand...

Quantity0

Price

Demand

Supply

Tax

1. When supply is moreelastic than demand...

2. ...theincidence of thetax falls moreheavily on

consumers...

3. ...than onproducers.

Price without tax

Price buyers pay

Price sellers receive


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Inelastic Supply,Elastic Demand...

Quantity0

Price

Demand

Supply

Price without tax

Tax

1. When demand is moreelastic than supply...

2. ...theincidence ofthe tax falls moreheavily on producers...

3. ...than on consumers.

Price buyers pay



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So, how is the burden of the

tax divided?

The burden of a

tax falls more

heavily on the side

of the market thatis less elastic.


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Summary

Price controls include price ceilings

and price floors.

A price ceiling is a legal maximum onthe 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.


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Summary

Taxes are used to raise revenue for

public purposes.

When the government levies a tax ona good, the equilibrium quantity of

the good falls.

A tax on a good places a wedgebetween the price paid by buyers and

the price received by sellers.


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Summary

The incidence of a tax refers to who

bears the burden of a tax.

The incidence of a tax does notdepend on whether the tax is levied

on buyers or sellers.

The incidence of the tax depends onthe price elasticities of supply and

demand.


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GraphicalReview

H t I it d d i d it i ht 2001 b H t I


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A Price Ceiling That Is Not Binding...

$4

3


Cones

0

Price ofIce-Cream

Cone

Demand

Supply

Priceceiling

Equilibrium

price

100

Equilibriumquantity


H t I it d d i d it i ht 2001 b H t I


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A Price Ceiling That Is Binding...

$3


Cones

0

Price ofIce-Cream

Cone

2

Demand

Supply

Equilibriumprice

Price

ceilingShortage

125

Quantitydemanded

75

Quantitysupplied



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Not Binding...

$4

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

Supply

Priceceiling

1. Initially,theprice ceiling

is notbinding...


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Binding...

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

S1

Priceceiling

S2 2. butwhen supplyfalls...

P2

3. the priceceiling becomesbinding...4. resulting

in a shortage.


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Rent Control in the ShortRun...


0


Demand

Supply

Controlled rent

Shortage

Supply anddemand forapartments

are relatively

inelastic


44/54


Rent Control in the LongRun...


0


Demand

Supply

Controlled rent

Shortage

Because thesupply anddemand for

apartments aremore elastic...

rent controlcauses a large

shortage


45/54


A Price Floor That Is Not Binding...

$3


Cones

0

Price ofIce-Cream

Cone

100

Equilibriumquantity

Equilibriumprice

Demand

Supply

Price

floor2

Harcourt Inc items and derived items copyright 2001 by Harcourt Inc


46/54

A Price Floor That Is Binding...

$3

Quantity of

Ice-CreamCones

0

Price ofIce-Cream

Cone

Equilibriumprice

Demand

Supply

Price floor$4

120

Quantitysupplied

80

Quantitydemanded

Surplus



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The Minimum Wage

Quantity of

Labor

0

Wage

Equilibriumwage

Labordemand

Laborsupply

A Free Labor Market

Equilibrium

employment


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The Minimum Wage

Minimumwage

Quantity of

Labor

0

Wage

Labordemand

Laborsupply

Quantity

supplied

Quantity

demanded

Labor surplus(unemployment)

A Labor Market with aMinimum Wage


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Buyers...

3.00


Price ofIce-Cream

Cone

100

D1

Supply, S1

A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).

D2


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Buyers...

3.00


Price ofIce-Cream

Cone

10090

$3.30

Pricebuyers

pay

D1

D2

Equilibrium

with tax

Supply, S1


2.80

Pricesellersreceive

Pricewithout

tax

Tax ($0.50)


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Impact of a 50 Tax on Sellers...

3.00


Price ofIce-Cream

Cone

10090

S1

S2

Demand, D1

Pricewithout

tax2.80

Price

sellersreceive

$3.30

Pricebuyers

pay


A tax on sellersshifts the

supply curve

upward by theamount of thetax ($0.50).

Tax ($0.50)

Equilibriumwith tax


52/54


A Payroll Tax

Quantity of

Labor

0

Wage

Wagewithout tax

Labordemand

Laborsupply

Tax wedge

Wage firmspay

Wage workers

receive


53/54


Elastic Supply, Inelastic Demand...

Quantity0

Price

Demand

Supply

Tax

1. When supply is moreelastic than demand...

2. ...theincidence of thetax falls moreheavily onconsumers...

3. ...than onproducers.

Price without tax

Price buyers pay



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Inelastic Supply,Elastic Demand...

Quantity0

Price

Demand

Supply

Price without tax

Tax

1. When demand is moreelastic than supply...

2. ...theincidence ofthe tax falls moreheavily on producers...

3. ...than on consumers.

Price buyers pay


6_Demand Supply Gove Policies

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