Ch06 Supply, Demand, and Government Policies PDF

ECON-UA 2 INTRODUCTION TO MICROECONOMICS CHAPTER 06 HANDOUT
DR. ANDREW PAIZIS - NYU
N. GREGORY MANKIW NINTH EDITION
PRINCIPLES OF
MICRO
ECONOMICS
CHAPTER
Supply, Demand, and
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?
license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
2
1
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
© 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 3
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
2
EXAMPLE 1: The market for apartments

Rental P S
price of
apartments
Equilibrium without
$800 price controls
D
Q
300
Quantity
of apartments
5
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
6
3
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
D
Qd = 400 Q
250 400
Qs = 250
7
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
8
4
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
10
5
EXAMPLE 2A: Not binding price floor

A price floor below the
The Market for Unskilled Labor
equilibrium price is not
binding – has no W S
effect on the market
outcome.
$9.00
W = $9.00 Price
$7.00
Q = 500 floor
D
L
500
11
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
12
6
Minimum Wage Laws

• 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
13
Minimum Wage Laws

• 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
14
7
Minimum Wage Laws

• 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
15
Active Learning 1: Price Controls

The market for P
The market for bicycles
140
bicycles is in S
130
equilibrium as in 120
the graph. 110
Determine the 100
effects of: 90
80 D
A. $90 price ceiling 70
B. $90 price floor 60
50
C. $120 price floor 400
Q
50 60 70 80 90 100 110 120 130
16
8
Active Learning 1A: $90 price ceiling

P The market for bicycles
The price falls to 140
S
$90. (binding price 130
ceiling below the 120
equilibrium) 110
100
Buyers demand Price ceiling
120 bicycles, 90
sellers supply 90, 80 D
leaving a shortage 70 shortage = 30
of 120-90 = 30 60
bicycles. 50
40
0 Q
50 60 70 80 90 100 110 120 130
17
Active Learning 1B: $90 price floor

Equilibrium price is P The market for bicycles
140
above the $90 price 130
S
floor, so the price
120
floor is not binding.
110
P = $100, 100
Price floor
Q = 100 bicycles. 90
80 D
70
60
50
40
0 Q
50 60 70 80 90 100 110 120 130
18
9
Active Learning 1C: $120 price floor

The price rises to P The market for bicycles
140
$120. (binding price 130 surplus = 60 S
floor above the
120
equilibrium) Price floor
110
100
Buyers demand 90
60 bicycles, sellers 80 D
supply 120, causing 70
a surplus of 120-60 60
= 60 bicycles. 50
40
0 Q
50 60 70 80 90 100 110 120 130
19
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
10
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
11
EXAMPLE 3: The market for pizza
P
S1
$10.00 Equilibrium
without tax
D1
Q
500
23
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.
24
12
EXAMPLE 3B: The new equilibrium

Effects of a $1.50 per unit New equilibrium:
tax on buyers Q = 450
P Sellers receive
PB = $11.00
S1 PS = $9.50
Tax
Buyers pay
$10.00
PB = $11.00
PS = $9.50
D1 Difference between
D2 them = PB - PS =
$1.50 = tax
450 500 Q
25
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
26
13
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 S1 pizzas only if P rises to
$11.50, to compensate
$10.00 for this cost increase.
Hence, a tax on sellers

D1 shifts the S curve up by
the amount of the tax.
Q
500
27
EXAMPLE 4B: The new equilibrium

Effects of a $1.50 per New equilibrium:
unit tax on sellers Q = 450
P Buyers pay
S2
PB = $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
28
14
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
© 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
®
29
Active Learning 2: Effects of a tax

The market for P The market for bicycles
140
bicycles is in S
130
equilibrium as in the 120
graph. Suppose the 110
government 100
imposes a tax on 90
buyers of $30 per 80 D
bicycle. 70
60
• Find the new 50
Q, PB, PS, and 40
incidence of tax. 0 Q
50 60 70 80 90 100 110 120 130
30
15
Active Learning 2: Answers

P The market for bicycles
140
S
• Q = 80 130
120
• PB = $110 PB = 110
• PS = $80 100 Tax =
90 $30
• Incidence
PS = 80 D
• buyers: $10 70
60
• sellers: $20
50
40
0 Q
50 60 70 80 90 100 110 120 130
31
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
16
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
Sellers’ share D burden of the tax.
of tax burden
Q
33
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
Price if no tax Sellers bear most

Tax
of the burden of
the tax.
Sellers’ share PS
of tax burden D
34
17
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
35
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.
36
18

Ch06 Supply, Demand, and Government Policies PDF

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Ch06 Supply, Demand, and Government Policies PDF

Uploaded by

Copyright:

Available Formats

ECON-UA 2 INTRODUCTION TO MICROECONOMICS CHAPTER 06 HANDOUT

DR. ANDREW PAIZIS - NYU

N. GREGORY MANKIW NINTH EDITION

EXAMPLE 1: The market for apartments

EXAMPLE 1A: Not binding price ceiling

EXAMPLE 1B: Binding price ceiling

The price ceiling is $800

EXAMPLE 1C: Binding price ceiling in long run

In the long run, supply The Market for Apartments

So, the shortage $800

Shortages and Rationing

EXAMPLE 2: The market for unskilled labor

EXAMPLE 2A: Not binding price floor

EXAMPLE 2B: Binding price floor

Minimum Wage Laws

Minimum Wage Laws

• Advocates of the minimum wage

Minimum Wage Laws

Active Learning 1: Price Controls

Active Learning 1A: $90 price ceiling

Active Learning 1B: $90 price floor

Active Learning 1C: $120 price floor

Evaluating Price Controls

Evaluating Price Controls

EXAMPLE 3: The market for pizza

EXAMPLE 3A: A $1.50 tax imposed on buyers

EXAMPLE 3B: The new equilibrium

EXAMPLE 3C: The incidence of a tax on buyers

EXAMPLE 4A: A $1.50 tax imposed on sellers

Effects of a $1.50 per The tax effectively

Hence, a tax on sellers

EXAMPLE 4B: The new equilibrium

The outcome is the same in both cases!

Active Learning 2: Effects of a tax

Active Learning 2: Answers

Elasticity and Tax Incidence

– But how exactly is the tax burden divided?

CASE 1: Elastic supply, inelastic demand

Buyers’ share P It’s easier for

CASE 2: Inelastic supply, elastic demand

Price if no tax Sellers bear most

Who pays the luxury tax?

CASE STUDY: Who Pays the Luxury Tax?

Hence, companies that build yachts pay most

You might also like