SUPPLY, DEMAND, AND GOVERNMENT POLICIES

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SUPPLY, DEMAND, AND GOVERNMENT POLICIES

• Chapter 6

Harcourt Brace Company
2
Supply, Demand, and Government Policies

• In 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.

3
Price Controls

• Are usually enacted when policymakers believe the
  market price is unfair to buyers or sellers.
• Result in government-created price ceilings and
  floors.

4
Price Ceilings Price Floors

• Price Ceiling
• ä A legally established maximum price
• at which a good can be sold.
• Price Floor
• ä A legally established minimum price at which
  a good can be sold.

5
Price Ceilings

• Two outcomes are possible when the government
  imposes a price ceiling
• ä The price ceiling is not binding if set above
  the equilibrium price.
• ä The price ceiling is binding if set below the
  equilibrium price, leading to a shortage.

6
A Price Ceiling That Is Not Binding
7
A Price Ceiling That Is Not Binding
Price of Ice-Cream Cone
Supply
4
3
Equilibrium price
Demand
Quantity of Ice-Cream Cones
0
100
Equilibrium quantity
8
A Price Ceiling That Is Not Binding
Price of Ice-Cream Cone
Supply
4
Price ceiling
3
Equilibrium price
Demand
Quantity of Ice-Cream Cones
0
100
Equilibrium quantity
9
A Price Ceiling That Is Binding
10
A Price Ceiling That Is Binding
Price of Ice-Cream Cone
Supply
Equilibrium price
3
2
Demand
Quantity of Ice-Cream Cones
0
11
A Price Ceiling That Is Binding
Price of Ice-Cream Cone
Supply
Equilibrium price
3
2
Price ceiling
Demand
Quantity of Ice-Cream Cones
0
12
A Price Ceiling That Is Binding
Price of Ice-Cream Cone
Supply
Equilibrium price
3
2
Price ceiling
Demand
Quantity of Ice-Cream Cones
0
75
125
Quantity supplied
Quantity demanded
13
A Price Ceiling That Is Binding
14
Effects of Price Ceilings

• A binding price ceiling creates
• . . . shortages because QD gt QS.
• ä Example Gasoline shortage of the 1970s
• . . . nonprice rationing
• ä Examples Long lines
• Discrimination by sellers

15
Price Floors

• When the government imposes a price floor, two
  outcomes are possible.
• ä The price floor is not binding if set below
  the equilibrium price.
• ä The price floor is binding if set above the
  equilibrium price, leading to a surplus.

16
A Price Floor That Is Not Binding
17
A Price Floor That Is Not Binding
Price of Ice-Cream Cone
Supply
Equilibrium price
3
Demand
Quantity of Ice-Cream Cones
0
100
Equilibrium quantity
18
A Price Floor That Is Not Binding
Price of Ice-Cream Cone
Supply
Equilibrium price
3
Price floor
2
Demand
Quantity of Ice-Cream Cones
0
100
Equilibrium quantity
19
A Price Floor That Is Binding
20
A Price Floor That Is Binding
Price of Ice Cream Cones
Supply
4
3
Equilibrium price
Demand
0
Quantity of Ice Cream Cones
21
A Price Floor That Is Binding
Price of Ice Cream Cones
Supply
4
Price floor
3
Equilibrium price
Demand
0
Quantity of Ice Cream Cones
22
A Price Floor That Is Binding
Price of Ice Cream Cones
Supply
4
Price floor
3
Equilibrium price
Demand
0
80
120
Quantity of Ice Cream Cones
Quantity demanded
Quantity Supplied
23
A Price Floor That Is Binding
24
Effects of a Price Floor

• A price floor prevents supply and demand from
  moving toward the equilibrium price and quantity.
• ä When the market price hits the floor, it can
  fall no further, and the market price equals the
  floor price.

25
Effects of a Price Floor

• A binding price floor causes . . .
• . . . a surplus because QS gt QD.
• . . . nonprice rationing as an alternative
  mechanism for rationing the good, using
  discrimination criteria.
• ä Examples The minimum wage
• Agricultural price supports

26
Quick Quiz!

• Define price ceiling and price floor and give an
  example of each.

27
Quick Quiz!

• Which leads to a shortage?

28
Quick Quiz!

• Which leads to a surplus?

29
Taxes

• Governments levy taxes to raise revenue for
  public purposes.

30
Taxes Impact

• Taxes discourage market activity.
• When a good is taxed, the quantity sold is
  smaller.
• Buyers and sellers share the tax burden.

31
Taxes

• Tax incidence is the study of who bears the
  burden of a tax.
• Taxes result in a change in market equilibriums.
• Buyers pay more and sellers receive less,
  regardless of whom the tax is levied on.

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Impact of a 50 Tax on Buyers
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Impact of a 50 Tax on Buyers
Price of Ice-Cream Cone
Supply, S1
3.00
D1
Quantity of Ice-Cream Cones
0
100
34
Impact of a 50 Tax on Buyers
Price of Ice-Cream Cone
Supply, S1
3.00
A tax on buyers shifts the demand curve
downward by the size of the tax (0.50).
D1
Quantity of Ice-Cream Cones
0
100
35
Impact of a 50 Tax on Buyers
Price of Ice-Cream Cone
Supply, S1
3.00
A tax on buyers shifts the demand curve
downward by the size of the tax (0.50).
D1
D2
Quantity of Ice-Cream Cones
0
100
36
Impact of a 50 Tax on Buyers
Price of Ice-Cream Cone
Supply, S1
Price without tax
Equilibrium without tax
3.00
Equilibrium with tax
D1
D2
Quantity of Ice-Cream Cones
0
100
37
Impact of a 50 Tax on Buyers
Price of Ice-Cream Cone
Supply, S1
3.30
Equilibrium without tax
Tax (0.50)
2.80
Equilibrium with tax
D1
D2
Quantity of Ice-Cream Cones
0
100
90
38
Impact of a 50 Tax on Buyers
Price of Ice-Cream Cone
Supply, S1
Price buyers pay
3.30
Equilibrium without tax
3.00
2.80
Price sellers receive
Equilibrium with tax
D1
D2
Quantity of Ice-Cream Cones
0
100
90
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Impact of a 50 Tax on Sellers
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Impact of a 50 Tax on Sellers
S1
3.00
Demand, D1
0
100
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Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S1
3.00
Equilibrium without tax
Demand, D1
0
100
42
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
S1
Equilibrium without tax
Demand, D1
0
100
43
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
S1
3.30
3.00
Demand, D1
0
100
90
44
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
Equilibrium
with tax
S1
3.30
3.00
Equilibrium without tax
Demand, D1
0
100
90
45
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
S2
Equilibrium
with tax
S1
3.30
Tax (0.50)
3.00
Price without tax
2.80
Equilibrium without tax
Demand, D1
0
100
90
46
Impact of a 50 Tax on Sellers
A tax on sellers shifts the supply curve upward
by the amount of the tax (0.50).
Price buyers pay
S2
Equilibrium
with tax
S1
3.30
Tax (0.50)
3.00
Price without tax
2.80
Equilibrium without tax
Price sellers receive
Demand, D1
0
100
90
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The Incidence of Tax

• In what proportions is the burden of the tax
  divided?
• How do the effects of taxes on sellers compare to
  those levied on buyers?

48
The Incidence of Tax

• The answers to these questions depends on the
  elasticity of demand and the elasticity of supply.

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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.

50
Elasticity and Tax Incidence

• The more inelastic the demand and the more
  elastic the supply, the larger the buyers share
  of the tax.
• The more elastic the demand and the more
  inelastic the supply, the larger the sellers
  share of the tax.

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Elastic Supply, Inelastic Demand
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Elastic Supply, Inelastic Demand
Price
Supply
Price without tax
Demand
Quantity
0
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Elastic Supply, Inelastic Demand
Price
Supply
Tax
Price without tax
Demand
Quantity
0
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Elastic Supply, Inelastic Demand
Price
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
Demand
Quantity
0
55
Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic than demand...
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
Demand
Quantity
0
56
Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic than demand...
Price buyers pay
Supply
2. ...the incidence of the tax falls more heavily
on consumers...
Tax
Price without tax
Price sellers receive
Demand
Quantity
0
57
Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic than demand...
Price buyers pay
Supply
2. ...the incidence of the tax falls more heavily
on consumers...
Tax
Price without tax
Price sellers receive
Demand
3. ...than on producers.
Quantity
0
58
Inelastic Supply, Elastic Demand
59
Inelastic Supply, Elastic Demand
Price
Supply
Price without tax
Demand
Quantity
0
60
Inelastic Supply, Elastic Demand
Price
Supply
Price without tax
Tax
Demand
Quantity
0
61
Inelastic Supply, Elastic Demand
Price
Price buyers pay
Supply
Price without tax
Tax
Demand
Price sellers receive
Quantity
0
62
Inelastic Supply, Elastic Demand
1. When demand is more elastic than supply...
Price
Price buyers pay
Supply
Price without tax
Tax
Demand
Price sellers receive
Quantity
0
63
Inelastic Supply, Elastic Demand
1. When demand is more elastic than supply...
Price
Price buyers pay
Supply
Price without tax
Tax
Demand
Price sellers receive
2. ...the incidence of the tax falls more
heavily on producers...
Quantity
0
64
Inelastic Supply, Elastic Demand
1. When demand is more elastic than supply...
Price
Price buyers pay
Supply
Price without tax
3. ...than on consumers.
Tax
Demand
Price sellers receive
2. ...the incidence of the tax falls more
heavily on producers...
Quantity
0
65
Quick Quiz

• Show how a tax on car buyers of 1,000 per car
  affects the quantity of cars sold and the price
  of cars.

66
Quick Quiz

• Show how a similar tax on car sellers affects
  quantity and price.

67
Conclusion

• The economy is governed by two kinds of laws
• ä The laws of supply and demand.
• ä The laws enacted by government.

68
Conclusion

• Price controls include price ceilings and price
  floors.

69
Conclusion

• Taxes are used to raise revenue for public
  purposes.

70
Conclusion

• Taxes are used to raise revenue for public
  purposes.
• Taxes create new price equilibriums in which
  buyers and sellers share the tax.

71
Conclusion

• Taxes are used to raise revenue for public
  purposes.
• Taxes create new price equilibriums in which
  buyers and sellers share the tax.
• The incidence of the tax depends on the price
  elasticities of supply and demand.

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SUPPLY, DEMAND, AND GOVERNMENT POLICIES

• End of Chapter 6

Harcourt Brace Company
73
(No Transcript)
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Figure 6-1a
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(b) A Price Ceiling That Is Binding
Figure 6-1b
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(a) The Price Ceiling on Gasoline Is Not Binding
(b) The Price Ceiling on Gasoline Is Binding
Price of
Price of
S
2
Gasoline
Gasoline
2. ...but when
supply falls...
S
Supply,
S
1
1
1. Initially,
P
2
the price
ceiling
is not
Price ceiling
Price ceiling
binding...
3. ...the price
P
P
1
1
ceiling becomes
4. ...
binding...
resulting
in a
Demand
Demand
shortage.
Quantity of
0
Quantity of
0
Q
Q
Q
Q
1
D
S
1
Gasoline
Gasoline
Figure 6-2
77
(a) Rent Control in the Short Run
(b) Rent Control in the Long Run
(supply and demand are inelastic)
(supply and demand are elastic)
Rental
Rental
Price of
Price of
Supply
Apartment
Apartment
Supply
Controlled rent
Controlled rent
Demand
Shortage
Shortage
Demand
Quantity of
0
0
Quantity of
Apartments
Apartments
Figure 6-3
78
Figure 6-4a
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(b) A Price Floor That Is Binding
Figure 6-4b
80
Figure 6-5
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Price of Ice-Cream Cone
Supply, S1
Price buyers pay
3.30
Equilibrium without tax
Tax (0.50)
3.00
Price without tax
A tax on buyers shifts the demand curve
downward by the size of the tax (0.50).
2.80
Price sellers receive
Equilibrium with tax
D1
D2
Quantity of Ice-Cream Cones
0
100
90
Figure 6-6
82
Figure 6-7
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Figure 6-8
84
(a) Elastic Supply, Inelastic Demand
Figure 6-9a
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(b) Inelastic Supply, Elastic Demand
Figure 6-9b