Interactive CH 06 Supply, Demand, and Government Policies 9e

N.
GREGORY MANKIW NINTH EDITION
PRINCIPLES OF
ECONOMICS
Supply, Demand, and

CHAPTER
6 Government Policies
Interactive PowerPoint Slides by:
V. Andreea Chiritescu
Eastern Illinois University
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 1
IN THIS CHAPTER
• What are price ceilings and price floors?
What are some examples of each?
• How do price ceilings and price floors affect
market outcomes?
• How do taxes affect market outcomes?
How do the effects depend on whether
the tax is imposed on buyers or sellers?
• What is the incidence of a tax?
What determines the incidence?
© 2021 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a 2
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
Government Policies
• Economists as policy advisers
– Use theories to help change the world for
the better.
• Policies
– Often have effects that their architects did
not intend or anticipate
– Alter the private market outcome
– Price controls
– Taxes
Controls on Prices
• Price ceiling:
– Legal maximum on the price at which a
good can be sold
– Example: Rent-control laws
• Price floor:
– Legal minimum on the price at which a
good can be sold
– Example: Minimum wage laws
ASK THE EXPERTS
Rent Control
“Local ordinances that limit rent increases for some
rental housing units, such as in New York and San
Francisco, have had a positive impact over the past
three decades on the amount and quality of broadly
affordable rental housing in cities that have used
them.”
Source: IGM Economic Experts Panel, February 7, 2012.
EXAMPLE 1: The market for apartments
Rental P S
price of
apartments
Equilibrium without
$800 price controls
D
Q
300
Quantity
of apartments
EXAMPLE 1A: Not binding price ceiling
A price ceiling above The Market for Apartments

the equilibrium price P S
is not binding— Price
$1000
has no effect on the ceiling
market outcome.
$800
P = $800
Q = 300
D
Q
300
EXAMPLE 1B: Binding price ceiling
The equilibrium price

The Market for Apartments
($800) is above the
P S
ceiling and therefore
illegal.
The price ceiling is $800

binding, causes a
Price
shortage. $500
ceiling
P = $500 shortage
Qd = 400 D
Q
250 400
Qs = 250
EXAMPLE 1C: Binding price ceiling in long run
In the long run, supply The Market for Apartments

and demand of rental
P S
apartments are more
price-elastic.
So, the shortage $800

is larger. Price
$500
ceiling
shortage
D
Q
150 450
Shortages and Rationing
• Because of shortage
– Sellers must ration the goods among
buyers
• Some rationing mechanisms:
– Long lines
– Discrimination according to sellers’ biases
– Are often unfair and inefficient
• The goods do not necessarily go to the
buyers who value them most highly
EXAMPLE 2: The market for unskilled labor
Wage W
paid to S
unskilled
workers
Equilibrium without
$9.00
price controls
D
L
500
Quantity of
unskilled workers
EXAMPLE 2A: Not binding price floor
A price floor below the
The Market for Unskilled Labor
equilibrium price is not
binding – has no effect W S
on the market
outcome.
W = $9.00 $9.00
Q = 500 Price
$7.00
floor
D
L
500
EXAMPLE 2B: Binding price floor
The equilibrium wage The Market for Unskilled Labor
($9) is below the floor
and therefore illegal. labor
W surplus S
Price
$10.25
The price floor is floor
binding, causes a
$9.00
surplus (i.e.,
unemployment).
W = $10.25
Qd = 400 D
L
Qs = 550 400 550
ASK THE EXPERTS
The Minimum Wage
“If the federal minimum wage is raised
gradually to $15-per-hour by 2020, the
employment rate for low-wage U.S. workers
will be substantially lower than it would be
under the status quo.”
Source: IGM Economic Experts Panel, September 22, 2015.
Minimum Wage Laws – 1
• The minimum wage has its greatest impact
on the market for teenage labor.
– Least skilled and least experienced
– Willing to accept a lower wage in exchange for
on-the-job training
– A 10% increase in minimum wage decreases
teenage employment by 1-3%
– Focus on the effects in short-run
– Long-run effects: harder to estimate, but more
relevant and likely larger
• Long-run effects:
– Increase in quantity supplied of labor
• Higher number of teenagers who choose to
look for jobs
• Advocates of the minimum wage
– One way to raise the income of working poor
– Workers who earn the minimum wage can
afford only a meager standard of living
• Opponents of the minimum wage: not the best
way to combat poverty
– Causes unemployment, encourages teenagers
to drop out of school, prevents some unskilled
workers from getting on-the-job training
– Minimum-wage workers
• Less than a third of minimum-wage earners
are in families with incomes below the
poverty line
• Many are teenagers from middle-class
homes working at part-time jobs for extra
spending money
Active Learning 1: Price Controls
The market for P
The market for bicycles
bicycles is in S
equilibrium as in
the graph.
Determine the
effects of:
D
A.$90 price ceiling
B.$90 price floor
C.$120 price floor 0 Q
Active Learning 1A: $90 price ceiling
P The market for bicycles
The price falls to
S
$90. (binding price
ceiling below the
equilibrium)
Buyers demand Price ceiling
120 bicycles,
sellers supply 90, D
leaving a shortage shortage = 30
of 120-90 = 30
bicycles.
0 Q
Active Learning 1B: $90 price floor
Equilibrium price is P The market for bicycles
above the $90 price S
floor, so the price
floor is not binding.
P = $100,
Price floor
Q = 100 bicycles.
D
0 Q
Active Learning 1C: $120 price floor
The price rises to P The market for bicycles
$120. (binding price surplus = 60 S
floor above the
equilibrium) Price floor
Buyers demand
60 bicycles, sellers
supply 120, causing D
a surplus of 120-60
= 60 bicycles.
0 Q
Evaluating Price Controls
• Markets are usually a good way to
organize economic activity
– Economists usually oppose price ceilings
and price floors
– Prices are not the outcome of some
haphazard process
– Prices have the crucial job of balancing
supply and demand
• Coordinating economic activity
Evaluating Price Controls
• Governments can sometimes improve
market outcomes
– Want to use price controls
• Because of unfair market outcome
• Aimed at helping the poor
– Often hurt those they are trying to help
– Other ways of helping those in need
• Rent subsidies
• Wage subsidies (earned income tax credit)
Taxes
• Government uses taxes
– To raise revenue for public projects
• Roads, schools, and national defense
• Tax incidence
– Manner in which the burden of a tax is
shared among participants in a market
– The government can make the seller or
the buyer to pay the tax
EXAMPLE 3: The market for pizza
P
S1
$10.00 Equilibrium
without tax
D1
Q
500
EXAMPLE 3A: A $1.50 tax imposed on buyers
Hence, a tax on buyers shifts
Effects of a $1.50 per unit
the D curve down by the
tax on buyers
amount of the tax.
P
S1 The price buyers pay is now
$1.50 higher than the market
$10.00 price P.
Tax
P would have to fall by $1.50
$8.50 to make buyers willing to buy
D1 same Q as before.
D2 E.g., if P falls from $10.00 to
500 Q $8.50, buyers are willing to
purchase 500 pizzas.
EXAMPLE 3B: The new equilibrium
Effects of a $1.50 per unit New equilibrium:
tax on buyers Q = 450
P Sellers receive
S1 PS = $9.50
PB = $11.00
Tax
Buyers pay PB =
$10.00 $11.00
PS = $9.50
D1 Difference between
them = PB - PS =
D2
$1.50 = tax
450 500 Q
EXAMPLE 3C: The incidence of a tax on buyers
• Tax incidence: how the burden of a tax is
shared among market participants
P
In our
S1
example, PB = $11.00
Tax
buyers pay $10.00
$1.00 more, PS = $9.50
sellers get
$0.50 less. D1
D2
Q
450 500
EXAMPLE 4A: A $1.50 tax imposed on sellers
Effects of a $1.50 per The tax effectively

unit tax on sellers raises sellers’ costs by
$1.50 per pizza.
P S2 Sellers will supply 500
$11.50 Tax S
1
pizzas only if P rises to
$11.50, to compensate
$10.00 for this cost increase.
Hence, a tax on sellers
shifts the S curve up by
D1 the amount of the tax.
Q
500
EXAMPLE 4B: The new equilibrium
Effects of a $1.50 per New equilibrium:

unit tax on sellers Q = 450
P Buyers pay PB =
S2
$11.00
S1
PB = $11.00 Sellers receive
Tax
$10.00 PS = $9.50
PS = $9.50
Difference between
D1 them = $1.50 = tax
450 500 Q
The outcome is the same in both cases!
The effects on P and Q, and the tax incidence
are the same whether the tax is imposed on
buyers or sellers!
P
A tax drives S1
PB = $11.00
Tax
a wedge $10.00
between the PS = $9.50
price buyers pay
and the price D1
sellers receive.
450 500 Q
Active Learning 2: Effects of a tax
The market for P The market for bicycles
bicycles is in S
equilibrium as in the
graph. Suppose the
government
imposes a tax on
buyers of $30 per D
bicycle.
• Find the new
Q, PB, PS, and
incidence of tax. 0 Q
Active Learning 2: Answers
P The market for bicycles
S
• Q = 80
• PB = $110 PB =
Tax =
• PS = $80 $30
• Incidence PS = D
• buyers: $10
• sellers: $20
0 Q
Elasticity and Tax Incidence
• When a good is taxed
– Buyers and sellers of the good share the
burden of the tax
– But how exactly is the tax burden divided?
• Depends on the elasticity of demand and
elasticity of supply
CASE 1: Elastic supply, inelastic demand
Buyers’ share P It’s easier for

of tax burden sellers than
PB S buyers to leave
the market.
Tax
Price if no tax
So buyers bear
PS
most of the burden
Sellers’ share D of the tax.
of tax burden
Q
CASE 2: Inelastic supply, elastic demand
It’s easier for

buyers than
P
Buyers’ share S sellers to leave
of tax burden the market.
PB Sellers bear most
Price if no tax of the burden of
Tax the tax.
Sellers’ share PS
D
of tax burden
Q
Who pays the luxury tax?
• 1990, Congress adopted a new luxury
tax
– On yachts, private airplanes, furs, jewelry,
expensive cars
– Goal: to raise revenue from those who
could most easily afford to pay
– Luxury items
• Demand is quite elastic
• Supply is relatively inelastic
CASE STUDY: Who Pays the Luxury Tax?
The market for yachts
Buyers’ share P
S In the short run,
of tax burden
supply is inelastic
PB
Tax
PS Demand is
D
Sellers’ share price-elastic
of tax burden Q
Hence, companies that build yachts pay most

of the tax.
THINK-PAIR-SHARE
Suppose that your state needs to raise more
tax revenue. The governor proposes a tax on
food because everyone must eat and, thus, a
food tax would surely raise a great deal of tax
revenue. He insists the tax should be placed on
food sellers to protect the poor who spend a
large proportion of their income on food.
A. Will the burden of a food tax fall only on the
sellers of food as the governor said? Explain.
B. Who will bear most of this tax burden? Explain.
CHAPTER IN A NUTSHELL
• A price ceiling is a legal maximum on the price of a
good or service. Example: rent control.
– Binding if below the equilibrium price: shortage.
– Sellers must in some way ration the good or
service among buyers.
• A price floor is a legal minimum on the price of a
good or service. Example: minimum wage.
– Binding if above the equilibrium price: surplus.
– Buyers’ demands for the good or service must in
some way be rationed among sellers.
CHAPTER IN A NUTSHELL
• When the government levies a tax on a good, the
equilibrium quantity of the good falls.
– The tax places a wedge between the price paid
by buyers and the price received by sellers.
– Buyers pay more for the good and sellers
receive less for it.
• Buyers and sellers share the tax burden.
– The incidence of tax depends on the price
elasticities of supply and demand.
– Most of the burden falls on the side of the
market that is less elastic.

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N.

GREGORY MANKIW NINTH EDITION

Supply, Demand, and

Source: IGM Economic Experts Panel, February 7, 2012.

A price ceiling above The Market for Apartments

The equilibrium price

The price ceiling is $800

In the long run, supply The Market for Apartments

So, the shortage $800

Source: IGM Economic Experts Panel, September 22, 2015.

Effects of a $1.50 per The tax effectively

Effects of a $1.50 per New equilibrium:

Buyers’ share P It’s easier for

It’s easier for

Hence, companies that build yachts pay most

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