ANNOUNCEMENTS

1
ANNOUNCEMENTS
Exam, Thursday, October 7
Chapters 1 - 6
Multiple choice and short answer.
Practice questions in workbook and on
homepage for Mankiws textbook.
2
ANNOUNCEMENTS
TEACHING ASSISTANTS FOR THIS COURSE
W. Wu BA 123A M 900 - 1100 AM Th 400 - 500
PM
S. Sadhu BA 129K M 200 - 300 PM W 115 - 315
PM
Assistants are available to help with text
material,
but NOT WITH HOMEWORK ASSIGNMENTS.
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ANNOUNCEMENTS
S. SADHU
For Wednesday, October 6, the office hours are
changed to 1240 - 230 PM. Next week, regular
time for office hours will resume (M 200-300 PM
and W115 - 315 PM).
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ANNOUNCEMENTS
The Economics Department also offers free
tutorial assistance. Schedules can be accessed
through the course homepage http//www.albany.edu
/twk58/eco110.html
Tutorial assistance is also available through
Educational Support Services.
5
GOVERNMENT MARKET POLICIES
We will consider two types of government
policies that affect free market outcomes
(1) Price Controls
(2) Sales taxes
6
PRICE CONTROLS
PRICE CEILING -- A legal maximum price
that the market price cannot legally exceed.
Market price can legally be at or below the
price ceiling, but not above it. Rent controls.
PRICE FLOOR -- A legal minimum price
that the market price cannot legally fall
below. Market price can legally be at or above
the price floor, but not below it. Minimum
wage.
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PRICE CEILING
Since prices can legally be below the price cei
ling, the equilibrium market price (PE) is a le
gal price, and the price ceiling will have no
effect on the market.
The ceiling is not binding
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PRICE CEILING
At the legal price ceiling (PL) the is excess qu
antity demanded, so market forces will try to
push up price. But this is not legal, so that t
he
EXCESS QUANTITY DEMANDED
market equilibrium price (P) cannot be legally
attained. The price ceiling is binding.
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EFFECTS OF A BINDINGPRICE CEILING
When the price ceiling is binding, market pric
e will be below equilibrium and there will be e
xcess demand. Therefore price cannot be used to
ration the
EXCESS QUANTITY DEMANDED
quantity supplied.
In this case a nonprice
mechanism for rationing quantity will appear.
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SOME KINDS OF NONPRICE RATIONING

• First come -- first serve
• Side payments
• Discrimination

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PRICE FLOOR
Since prices can legally be above the price flo
or, the equilibrium market price (PE) is a lega
l price, and the price ceiling will have no ef
fect on the market.
The floor is not binding
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PRICE FLOOR
At the legal price floor (PL) there is excess q
uantity supplied, so market forces will try to
push price down. But this is not legal, so that
the market equilibrium price (P) cannot be
EXCESS QUANTITY SUPPLIED
legally attained. The price ceiling is binding.
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EFFECTS OF A BINDING PRICE FLOOR
When the price floor is binding, market price wi
ll be above equilibrium and there will be excess
supply. Therefore price cannot be used to
determine who gets to sell.
EXCESS QUANTITY SUPPLIED
In this case a nonprice mechanism for deciding
who gets to sell will established by buyers.
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SOME KINDS OF NONPRICE RATIONING

• First come -- first serve
• Side payments
• Discrimination

15
SALES TAX
Suppose the government imposes a sales tax on
a particular good. The tax is to be paid by the
buyer. Suppose that the tax is 10 cents per unit
sold. If the buyer buys 50 units of the good, in
addition to paying the purchase price of the good
to the seller, she must also pay the government
5.00 (50 x 0.10). For example, the New York
State sales tax on cigarettes must be paid by any
consumer bringing cigarettes from another state.
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SALES TAX
If consumers are willing to purchase 20 units
of the good per week when the price is 1.00 per
unit, and 18 units per week when the price is 1
.10 per unit, quantity demanded will fall from 20
units per week to 18 units per week when the tax
raises the price (including tax) to the buyer fr
om 1.00 to 1.10 per unit.
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SALES TAX
When the buyer pays 1.00 for the good, the actu
al cost to the buyer is 1.10 including the sa
les tax. Therefore the buyer
demands the quantity that would have been
purchased at 1.10 even though the
0.10
0.10
market price is 1.00.
This is true at every price.
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SALES TAX
Therefore the buyer acts as if she is paying 10 c
ents more than the price charged by the seller
-- so that the demand curve shifts down by the
amount of the tax (10 cents).
D
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SALES TAX
Since the demand curve shifts down (by the amou
nt of the tax), the equilibrium price falls from
PE to PE.

TAX
TAX
However the decrease in the equilibrium price is

less than the tax.
Therefore the buyer does not pay the entire tax.
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SALES TAX
Since the increase in the price paid by the buyer
from the old equilibrium price PE to the new p
rice PETAX is less than the tax, the buyer do
es not pay all of the tax.
TAX
PETAX
Part of the
tax is paid by the seller. The old price
received by the seller was PE and the new price
is PE.
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SALES TAX INCIDENCE
Who bears the burden of the tax?
The manner in which the tax is distributed
to the buyer, as an increase in price paid, and
to the seller, as a decrease in the price receive
d, is called the incidence of the tax.
Note that the difference between the price paid
by the buyer and the price received by the
seller is the tax -- the amount received by the
government.
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SALES TAX INCIDENCE
The buyers burden is PE TAX - PE
BUYERS BURDEN
TAX
The sellers burden is PE - PE
PETAX
The total burden is (PETAX-PE)(PE-PE)
TAX

SELLERS BURDEN
Buyers pay sellers PE and the TAX to the govt.
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SALES TAXES
Now suppose the government imposes a sales tax on
a particular good to be paid by the seller.
Suppose that the tax is 10 cents per unit sold.
(For example the federal tax on gasoline at the
pump is 18.3 cents per gallon collected by the
seller and paid to the government.)
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SALES TAX
If suppliers were willing to sell 20,000 gallons
of gasoline per week when the price is 1.00 per
gallon, and 22,000 gal. per week when the price
is 1.10 per gallon, quantity supplied will fall
from 20,000 gals. per week to 22,000 gals. per
week when the price rises from 1.00 to 1.10 pe
r gal.
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SALES TAX
Since the sellers cost of supplying this good ha
s increased by the amount of the tax, sellers wi
ll try to increase the price at which they are w
illing to supply any quantity by the amount of t
he tax.
TAX
S
The supply curve will shift up by the amount of
tax.
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SALES TAX INCIDENCE
Although sellers attempt to raise price by the am
ount of the tax, buyers respond to the higher pri
ce by decreasing quantity demanded and pushing
down price to PE. Therefore the price to
PE TAX
BUYERS BURDEN
buyers increases from PE to PE.
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SALES TAX INCIDENCE
Since sellers are not successful in raising price
by the full amount of the tax, they bear some
of the tax burden, namely the
part not paid by buyers.
SELLERS BURDEN
PE TAX
TAX
BUYERS BURDEN
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SALES TAX INCIDENCE
The buyers burden is PE - PE The s
ellers burden is PE TAX - PE The total
burden is (PE-PE) (PETAX-PE)
TAX
SELLERS BURDEN
PE TAX
TAX
BUYERS BURDEN
Buyers pay sellers PE and sellers pay the tax
to
the government.
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SALES TAX INCIDENCE
Does it make any difference whether the tax is
paid to the government by the buyer or the
seller?
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SALES TAX INCIDENCE
If the tax is levied on the buyer, market price i
s PE, the buyers burden is PE-PE and the sell
ers burden is PE-PE.

S
TAX
PE
If the tax is levied on sellers, their burden is
PE-PE, the buyers burden is PE-PE,
and market price is PE.
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SALES TAX INCIDENCE
Therefore the incidence of the tax does not
depend on whether the tax is levied on the buyer
or seller. Buyers will bear the same burden in
either case, as will sellers. The only differenc
e is who is performing the work as tax collector
for the government.
Since it is easier for the government to
administer a tax collected by sellers, this is th
e usual type of
sales tax.
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ELASTICITY AND SALES TAX INCIDENCE
With demand D1, the buyers burden is the incr
ease in market price
PE1-PE.
PE2
For demand D2, the buyers burden is PE1 - PE
2 -- smaller
than for demand curve D1.
D2
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ELASTICITY AND SALES TAX INCIDENCE
Since demand curve D1 is more inelastic than dem
and curve D2, the buyers burden is larger the l
ess elastic
demand, ceteris paribus.
PE2
D2
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ELASTICITY AND SALES TAX INCIDENCE
With supply curve S1, the buyers burden is TAX
-(PE - PE1) PE1-P.

S2
With supply curve S2, the buyers burden is TAX
-(PE - PE2) PE2-P -- smaller than with suppl
y curve S1.
PE2
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ELASTICITY AND SALES TAX INCIDENCE
Since supply curve S1 is more elastic than supply
curve S2, the buyers burden is greater the m
ore elastic supply.
S2
PE2
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ELASTICITY AND SALES TAX INCIDENCE
Conversely, the sellers burden is greater the
more elastic demand and the more inelastic
supply.