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Unformatted text preview: Supply, Demand, and Government Policies
• In a free, unregulated market system, the market prices established by the forces of supply and demand may be perceived as unfair by either side of the market. • Their political representatives may argue for and push through price control policies. CONTROLS ON PRICES
• Price Ceiling
– A legal _________ on the price at which a good can be sold – We will use urban rent control has a case in point. EXAMPLE 1: The Market for Apartments
Rental price of NYC apts P S $800 Eq’m w/o price controls
D 300 Q Quantity of apartments How Price Ceilings Affect Market Outcomes
A price ceiling above the eq’m price is __________ – it has no effect on the market outcome.
P $1000 $800 S Price ceiling D 300 Q How Price Ceilings Affect Market Outcomes
P The eq’m price ($800) is above the ceiling and therefore illegal. The ceiling is a _______ constraint on the price, and causes a shortage. S $800 $500 _______ 250 400 D Price ceiling Q How do we resolve shortage?
• With a shortage, sellers must ration the goods among buyers. • Some rationing mechanisms: (1) long lines (2) discrimination according to sellers’ biases • These mechanisms are often unfair, and inefficient: the goods don’t necessarily go to the buyers who value them most highly. • In contrast, free markets ration good by prices. Therefore, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair). Does rent control work?
– Those who can still rent benefit from lower rents (P<Pe) – But some can no longer rent an apartment (Qs<Qe<Qd) or need to incur additional costs to get an apartment • Landlords
– Lose from the policy: lower rent, fewer units rented • Any long-run effects? How Price Ceilings Affect Market Outcomes
P S In the long run, supply and demand are more __________. So, the shortage is larger. $800 $500 shortage 150 450 Price ceiling D Q CASE STUDY: Lines at the Gas Pump
• In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so 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. (a) The Price Ceiling on Gasoline Is Not Binding Price of Gasoline Supply,S1 1. Initially, the price ceiling is not binding . . . P1 Price ceiling Demand 0 Q1 Quantity of Gasoline (b) The Price Ceiling on Gasoline Is Binding Price of Gasoline S2 2. . . . but when supply falls . . . S1 P2 Price ceiling P1 4. . . . resulting in a shortage. 0 QS QD Q1 3. . . . the price ceiling becomes binding . . . Demand Quantity of Gasoline • A modern day example:
– Zimbabwe’s price control policy that President Mugabe installed to tame inflation and buy popular support. http://www.youtube.com/watch?v =nuFAWuJw4gM CONTROLS ON PRICES
• Price Floor
– A legal ________ on the price at which a good can be sold – We will use minimum wage as a case in point. EXAMPLE 2: The Market for Unskilled Labor Wage paid to unskilled workers W S $4 Eq’m w/o price controls
500 D L Quantity of unskilled workers How Price Floors Affect Market Outcomes A price floor below the eq’m price is not binding – it has no effect on the market outcome. W S $4 $3 D 500 Price floor L How Price Floors Affect Market Outcomes W
The eq’m wage ($4) is below the floor and therefore illegal. The floor is a _______ constraint on the wage, and causes a surplus (i.e., _________). labor surplus S $5 $4 Price floor D 400 550 L The Minimum Wage Min wage laws do not affect ________ workers. They do affect teen workers. Studies: A 10% increase in the min wage raises teen unemployment by 1-3%. W $5 $4 unemployment S Min. wage D 400 550 L Does minimum wage policy serve its intentions? • It may.
• Total wages paid out rise if extra wages earned by those still employed outweigh the wages lost by those now out of work
• But This only happens if the price elasticity of labor demand is _______ 1. Does minimum wage policy serve its intentions? • It may not.
• The number unemployed is greater than the number of people who lose jobs (e.g. extra high-school drop-outs). • The fall in employment may be larger in the long run as demand becomes more elastic. • More incentive for blackmarkets (illegal deals between buyers and sellers) • A more directly targeted income program might have been more effective. TAXES
• The gov’t levies taxes on many goods & services to
– raise revenue to pay for public projects, such as national defense, public schools, etc. – influence market outcomes (to be discussed later) • The govt can make buyers or sellers pay the tax.
– The difference looks very large on the surface. – But the real burden is more of interest to us: This is the study of ____________ EXAMPLE 3: The Market for Pizza
Eq’m w/o tax
$10.00 P S1 D1 500 Q A Tax on Sellers
A tax on sellers shifts the S curve ___ by the amount of the tax. The price buyers pay rises, the price sellers receive falls, eq’m Q falls.
P PB = $11.00 $10.00 PS = $9.50 D1 430 500 Q Effects of a $1.50 per unit tax on sellers
S2 Tax S1 Lessons when seller is paying the $1.50 tax: • Total number of pizza bought and sold in the market is reduced from 500 to 430.
– “If you want less of something, tax it” • Buyers now pay $11 per pizza, $1 higher than the pre-tax price. • Sellers now receive $9.5 per pizza, $0.50 less than the pre-tax price. • Both of them share the burden. A Tax on Buyers
A tax on buyers shifts the D curve ____ by _________
The price buyers pay rises, the price sellers receive falls, eq’m Q falls.
P PB = $11.00 $10.00 PS = $9.50 D1 D2 430 500 Q Effects of a $1.50 per unit tax on buyers
S1 Tax Lessons when buyer is paying the $1.50 tax: • Total number of pizza bought and sold in the market is reduced from 500 to 430.
– “If you want less of something, tax it” • Buyers now pay $11 per pizza, $1 higher than the pre-tax price. • Sellers now receive $9.5 per pizza, $0.50 less than the pre-tax price. • Both of them share the burden. The Outcome Is the Same in Both Cases!
(Amazing result!) 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: A tax drives a wedge between the price buyers pay and the price sellers receive. PB = $11.00 $10.00 PS = $9.50 Tax S1 D1 430 500 Q Practice: Effects of a tax Effects
130 The market for hotel rooms S Suppose govt imposes a tax on buyers of $30 per room. Find new Q , P B , P S, and incidence of tax. 120 110 100 90 80 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130
28 D Figure 9 How the Burden of a Tax Is Divided
(a) 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 Demand 2. . . . the incidence of the tax falls more heavily on consumers . . . Quantity Figure 9 How the Burden of a Tax Is Divided
(b) Inelastic Supply, Elastic Demand Price 1. When demand is more elastic than supply . . . Price buyers pay Price without tax Tax Supply 3. . . . than on consumers. Price sellers receive 2. . . . the incidence of the tax falls more heavily on producers . . . Demand 0 Quantity Elasticity and Tax Incidence
• If buyers’ price elasticity > sellers’ price elasticity, buyers can more easily leave the market when the tax is imposed, so buyers will bear a smaller share of the burden of the tax than sellers. • If sellers’ price elasticity > buyers’ price elasticity, the reverse is true. • So the government cannot decide who bears the tax burden. It’s determined by the relative elasticity in the market. Elasticity and Tax Incidence 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 _____ elastic. Some further thought experiments… • So who pays more tax when excise tax is imposed, i.e. tax on cigarettes or alcohol? • The government collects the same amount of tax revenue regardless of how the tax is levied. So do market elasticities matter for total tax revenues? ...
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