supply, demand and government policies chapter 6 copyright © 2001 by harcourt, inc. all rights...
TRANSCRIPT
Supply, Demand and Government Policies
Chapter 6
Copyright © 2001 by Harcourt, Inc.
All rights reserved. Requests for permission to make copies of any part of the
work should be mailed to:
Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Supply, Demand, and Government Policies
In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
One of the things government can do is to set price controls when the market price is seen as unfair to either buyers or sellers.
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Price Ceilings & Price Floors
Price Ceiling A legally established maximum price at which a
good can be sold. (Rent Controls)
Price Floor A legally established minimum price at which a
good can be sold. (Price Supports for Agriculture)
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Price Ceilings
Two outcomes are possible when the government imposes a price ceiling:
The price ceiling is not binding if set above the equilibrium price.
The price ceiling is binding if set below the equilibrium price, leading to a shortage.
Binding means that there is an economic impact.
A Price Ceiling That Is Binding...
$3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
2
Demand
Supply
Equilibriumprice
Priceceiling
Shortage
125Quantity
demanded
75Quantitysupplied
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A Price Ceiling That Is Not Binding...
$4
3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Demand
Supply
Priceceiling
Equilibriumprice
100Equilibrium
quantity
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Effects of Price Ceilings
A binding price ceiling creates ... shortages because QD > QS.
Example: Gasoline shortage of the 1970s
nonprice rationing Examples: Long lines, Discrimination
by sellers
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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...
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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.
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Rent Control Rent controls are ceilings placed on the
rents that landlords may charge their tenants.
Rent control can make housing more affordable.
With a price ceiling, you cannot go above the ceiling.
But what about the landlords?
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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-Why is the supply
curve vertical?
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Rent Control in the Long Run...
Quantity ofApartments
0
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Because the supply and demand for
apartments are more elastic...
What happens in the long run?
…rent control causes a
large shortage
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Price Floors
When the government imposes a price floor, two outcomes are possible.
The price floor is not binding if set below the equilibrium price.
The price floor is binding if set above the equilibrium price, leading to a surplus.
Think of price floors as not being able to go below the floor.
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A Price Floor That Is Not Binding...
$3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
100Equilibrium
quantity
Equilibrium
price
Demand
Supply
Pricefloor2
A Price Floor That Is Binding...
$3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Equilibrium
price
Demand
Supply
Price floor$4
120Quantitysupplied
80Quantity
demanded
Surplus
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Effects of a Price Floor
A binding price floor causes . . . a surplus because QS >QD.
nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria.
Examples: The minimum wage, Agricultural price supports State Minimum Wages
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The Minimum Wage
Quantity ofLabor
0
Wage
Equilibrium
wage
Labor demand
Labor supply
A Free Labor Market
Equilibriumemploymen
t
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Minimumwage
The Minimum Wage
Quantity ofLabor
0
Wage
Labor demand
Labor supply
Quantitysupplied
Quantitydemanded
Labor surplus(unemployment)
A Labor Market with a Minimum Wage
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What are some potential impacts of taxes?
Taxes are used to raise money for the government.
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden.
But who bears the burden-tax incidence.
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
10090
$3.30
Pricebuyers
pay
D1
D2
Equilibriumwith tax
Supply, S1
Equilibrium without tax
Impact of a 50¢ Tax Levied on Buyers...
2.80
Pricesellersreceive
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Pricewithout
tax
Tax ($0.50)
3.00
Quantity ofIce-Cream Cones
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
Equilibrium without tax
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A tax on sellers shifts the supply
curve upward by the
amount of the tax ($0.50).
Tax ($0.50)
Equilibriumwith tax
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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?
The answers to these questions depend on the elasticity of demand
and the elasticity of supply.
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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
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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
Price sellers receive