Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Repealing the Laws of Supply and Demand: Price Controls Price Ceiling u A legally.

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

Repealing the Laws of Supply and Demand:

Price ControlsPrice 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.

A Price Ceiling That Is Not Binding...

$4

3

Quantity ofIce-Cream

Cones

0

Price ofIce-Cream

Cone

Demand

Supply

Priceceiling

Equilibriumprice

100Equilibrium

quantity


A Price Ceiling That Is Binding...

$3


Cones

0

Price ofIce-Cream

Cone

2

Demand

Supply

Equilibriumprice

Priceceiling

Shortage

125Quantity

demanded

75Quantitysupplied



The 1970s Energy Crisis: The Price Ceiling on Gasoline

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

S1

Priceceiling

S2 2. …but when supply falls...

P2

3. …the price ceiling becomes binding...

4. …resulting in a shortage.


Rent Control in the Short Run...

Quantity ofApartments

0

Rental Price of

Apartment

Demand

Supply

Controlled rent

Shortage

Supply and demand for apartments

are relatively inelastic


Rent Control in the Long Run...


0

Rental Price of

Apartment

Demand

Supply

Controlled rent

Shortage

Because the supply and demand for

apartments are more elastic...

…rent control causes a

large shortage


The Minimum Wage: An important example of a price floor …


A Free Labor Market

Quantity ofLabor

0

Wage

Equilibrium

wage

Labor demand

Labor supply

Equilibriumemploymen

t


Minimumwage

The Minimum Wage

Quantity ofLabor

0

Wage

Labor demand

Labor supply

Quantitysupplied

Quantitydemanded

Labor surplus(unemployment)

A Labor Market with a Minimum Wage


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?


Taxes

Governments levy taxes to raise revenue for public

needs.


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.

Impact of a 50¢ Tax Levied on Buyers...

3.00

Quantity ofIce-Cream Cones

0

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

3.00


0

Price ofIce-Cream

Cone

10090

$3.30

Pricebuyers

pay

D1

D2

Equilibriumwith tax

Supply, S1

Equilibrium without tax


2.80

Pricesellersreceive


Pricewithout

tax

Tax ($0.50)


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.


3.00


0

Price ofIce-Cream

Cone

10090

S1

S2

Demand, D1

Impact of a 50¢ Tax on Sellers...

Price without tax

2.80

Price sellers receiv

e

$3.30

Price buyers

pay



A tax on sellers shifts the supply

curve upward by the

amount of the tax ($0.50).

Tax ($0.50)

Equilibriumwith tax


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.



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

Price sellers receive


Inelastic Supply, Elastic Demand...

Quantity0

Price

Demand

Supply

Price without tax

Tax

1. When demand is moreelastic than supply...

2. ...theincidence of the tax falls more heavily on producers...

3. ...than on consumers.

Price buyers pay



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.


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.


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.


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.


Graphical Review

A Price Ceiling That Is Not Binding...

$4

3


Cones

0

Price ofIce-Cream

Cone

Demand

Supply

Priceceiling

Equilibriumprice

100Equilibrium

quantity


A Price Ceiling That Is Binding...

$3


Cones

0

Price ofIce-Cream

Cone

2

Demand

Supply

Equilibriumprice

Priceceiling

Shortage

125Quantity

demanded

75Quantitysupplied



The Price Ceiling on Gasoline Is Not Binding...

$4

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

Supply

Priceceiling

1. Initially, the price ceiling is not binding...


The Price Ceiling on Gasoline Is Binding...

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

S1

Priceceiling

S2 2. …but when supply falls...

P2

3. …the price ceiling becomes binding...

4. …resulting in a shortage.


Rent Control in the Short Run...


0

Rental Price of

Apartment

Demand

Supply

Controlled rent

Shortage

Supply and demand for apartments

are relatively inelastic


Rent Control in the Long Run...


0

Rental Price of

Apartment

Demand

Supply

Controlled rent

Shortage

Because the supply and demand for

apartments are more elastic...

…rent control causes a

large shortage


A Price Floor That Is Not Binding...

$3


Cones

0

Price ofIce-Cream

Cone

100Equilibrium

quantity

Equilibrium

price

Demand

Supply

Pricefloor2

A Price Floor That Is Binding...

$3


Cones

0

Price ofIce-Cream

Cone

Equilibrium

price

Demand

Supply

Price floor$4

120Quantitysupplied

80Quantity

demanded

Surplus



The Minimum Wage

Quantity ofLabor

0

Wage

Equilibrium

wage

Labor demand

Labor supply

A Free Labor Market

Equilibriumemploymen

t


The Minimum Wage

Minimumwage

Quantity ofLabor

0

Wage

Labor demand

Labor supply

Quantitysupplied

Quantitydemanded

Labor surplus(unemployment)

A Labor Market with a Minimum Wage



3.00


0

Price ofIce-Cream

Cone

100

D1

Supply, S1

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

D2



3.00


0

Price ofIce-Cream

Cone

10090

$3.30

Pricebuyers

pay

D1

D2

Equilibriumwith tax

Supply, S1


2.80

Pricesellersreceive

Pricewithout

tax

Tax ($0.50)


Impact of a 50¢ Tax on Sellers...

3.00


0

Price ofIce-Cream

Cone

10090

S1

S2

Demand, D1

Price without tax

2.80

Price sellers receiv

e

$3.30

Price buyers

pay


A tax on sellers shifts the supply

curve upward by the

amount of the tax ($0.50).

Tax ($0.50)

Equilibriumwith tax


A Payroll Tax

Quantity ofLabor

0

Wage

Wage without

tax

Labor demand

Labor supply

Tax wedge

Wage firms pay

Wage workers receive


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



Inelastic Supply, Elastic Demand...

Quantity0

Price

Demand

Supply

Price without tax

Tax

1. When demand is moreelastic than supply...

2. ...theincidence of the tax falls more heavily on producers...

3. ...than on consumers.

Price buyers pay


Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. Repealing the Laws of Supply and Demand: Price Controls Price Ceiling u A legally.

Documents

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derived items copyright

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new market price