Lecture Principles of economics - Chapter 6: Supply, demand, and government policies

In this chapter you will examine the effects of government policies that place a ceiling on prices, examine the effects of government policies that put a floor under prices, consider how a tax on a good affects the price of the good and the quantity sold, learn that taxes levied on buyers and taxes levied on sellers are equivalent.

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Supply, Demand, and Government

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CONTROLS ON PRICES

• Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.

• Result in governmentcreated price ceilings and floors.

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How Price Ceilings Affect Market Outcomes

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Figure 1 A Market with a Price Ceiling

(a) A Price Ceiling That Is Not Binding

Quantity of Ice-Cream Cones

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Figure 1 A Market with a Price Ceiling

(b) A Price Ceiling That Is Binding

75 Quantity supplied

125 Quantity demanded

Equilibrium

price

$3

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How Price Ceilings Affect Market Outcomes

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gasoline.

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Figure 2 The Market for Gasoline with a Price Ceiling

(a) The Price Ceiling on Gasoline Is Not Binding

Quantity of Gasoline

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Figure 2 The Market for Gasoline with a Price Ceiling

(b) The Price Ceiling on Gasoline Is Binding

Quantity of Gasoline

0

Price of Gasoline

2 but when supply falls

P2

Q D

P1

Q1

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CASE STUDY: Rent Control in the Short Run

and Long Run

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Figure 3 Rent Control in the Short Run and in the Long Run

(a) Rent Control in the Short Run (supply and demand are inelastic)

Quantity of Apartments

0

Supply

Controlled rent

Rental Price of

Apartment

Demand Shortage

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Figure 3 Rent Control in the Short Run and in the Long Run

(b) Rent Control in the Long Run (supply and demand are elastic)

0

Rental Price of

Apartment

Quantity of Apartments

Demand

Supply

Controlled rent Shortage

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How Price Floors Affect Market Outcomes

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Figure 4 A Market with a Price Floor

(a) A Price Floor That Is Not Binding

2

Price floor

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Figure 4 A Market with a Price Floor

(b) A Price Floor That Is Binding

0

Price of Ice-Cream

80 Quantity demanded

120 Quantity supplied

Equilibrium

price

Surplus

3

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• 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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The Minimum Wage

• An important example of a price floor is the

minimum wage. Minimum wage laws dictate

the lowest price possible for labor that any

employer may pay

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Figure 5 How the Minimum Wage Affects the Labor Market

Quantity of Labor

Wage

0

Labor demand

Labor Supply

Equilibrium employment Equilibrium

wage

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Figure 5 How the Minimum Wage Affects the Labor Market

Quantity of Labor

Wage

0

Labor Supply Labor surplus

(unemployment)

Labor demand

Minimum

wage

Quantity demanded

Quantity supplied

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TAXES

• Governments levy taxes to raise revenue for

public projects.

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How Taxes on Buyers (and Sellers) Affect

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Elasticity and Tax Incidence

• Tax incidence is the manner in which the

burden of a tax is shared among participants in

a market

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Figure 6 A Tax on Buyers

0

Price of Ice-Cream

by the size of the tax ($0.50).

$3.30

90

Equilibrium with tax 2.803.00

100

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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 sellers share the tax burden.

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Figure 7 A Tax on Sellers

2.80

Equilibrium without tax Tax ($0.50)

by the amount of the tax ($0.50).

3.00

100

$3.30

90

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Figure 8 A Payroll Tax

Wage firms pay

Wage without tax

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Figure 9 How the Burden of a Tax Is Divided

Price buyers pay

(a) Elastic Supply, Inelastic Demand

2 the incidence of the tax falls more heavily on consumers

1 When supply is more elastic than demand

Price without tax

3 than

on producers.

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Figure 9 How the Burden of a Tax Is Divided

Price buyers pay

(b) Inelastic Supply, Elastic Demand

3 than on consumers.

1 When demand is more elastic than supply

Price without tax

2 the incidence of the tax falls more heavily

on producers

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