CHAPTER

6
Supply, Demand, and
Government Policies
Economics
N. Gregory Mankiw

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In this chapter,
look for the answers to these questions:
 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?
2
 Government Policies That Alter the
Private Market Outcome
 Price controls
 Price ceiling: a legal maximum on the price
of a good or service
 Price floor: a legal minimum on the price of
a good or service
 Taxes
 The govt can make buyers or sellers pay a
specific amount on each unit bought/sold.

We will use the supply/demand model to see

how each floors and ceilings affect the market
outcome. We will save taxes for Econ 202.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 3
 Price control

SUPPLY, DEMAND, AND GOVERNMENT POLICIES 4

 EXAMPLE 1: The Market for Apartments

Rental P S
price of
apts
$800
Eq’m w/o
price
controls
D
Q
300
Quantity of
apartments
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
 How Price Ceilings Affect Market Outcomes

A price ceiling P S
above the Price
eq’m price is $1000
ceiling
not binding –
it has no effect $800
on the market
outcome.

D
Q
300

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

 How Price Ceilings Affect Market Outcomes

The eq’m price P S

($800) is above
the ceiling and
therefore illegal.
$800
The ceiling
is a binding Price
$500
constraint ceiling
on the price, shortage
D
and causes Q
250 400
a shortage.

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

 How Price Ceilings Affect Market Outcomes

In the long run, P S

supply and
demand
are more $800
price-elastic.
Price
So, the $500
ceiling
shortage shortage
is larger. D
Q
150 450

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

 EXAMPLE 2: The Market for Unskilled Labor

Wage W S
paid to
unskilled
workers
$4

Eq’m w/o
price
controls
D
L
500
Quantity of
unskilled workers
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
 How Price Floors Affect Market Outcomes

A price floor W S
below the
eq’m price is
not binding –
it has no effect $4
on the market Price
outcome. $3
floor

D
L
500

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

 How Price Floors Affect Market Outcomes
labor
The eq’m wage ($4) W surplus S
is below the floor Price
and therefore $5
floor
illegal.
The floor $4
is a binding
constraint
on the wage,
and causes D
a surplus L
400 550
(i.e.,
unemployment).

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

 The Minimum Wage
Min wage laws unemp-
do not affect W loyment S
Min.
highly skilled $5
wage
workers.
They do affect $4
teen workers.
Studies:
A 10% increase
in the min wage D
L
raises teen 400 550
unemployment
by 1-3%.
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
A C T I V E L E A R N I N G 1:
Price floors The market for
P
140 hotel rooms
& ceilings S
130
Determine 120
effects of: 110
A. $90 price 100
ceiling 90
80 D
B. $90 price
70
floor
60
C. $120 price 50
floor 40
0 Q
50 60 70 80 90 100 110 120 130
13
A C T I V E L E A R N I N G 1:
A. $90 price ceiling The market for
P
140 hotel rooms
S
The price 130
falls to $90. 120
110
Buyers
100
demand Price ceiling
90
120 rooms,
80 D
sellers supply shortage = 30
70
90, leaving a
60
shortage.
50
40
0 Q
50 60 70 80 90 100 110 120 130
14
A C T I V E L E A R N I N G 1:
B. $90 price floor The market for
P
140 hotel rooms
S
Eq’m price is 130
above the floor, 120
so floor is not 110
binding. 100
90
P = $100, Price floor
Q = 100 rooms. 80 D
70
60
50
40
0 Q
50 60 70 80 90 100 110 120 130
15
A C T I V E L E A R N I N G 1:
C. $120 price floor The market for
P
140 hotel rooms
surplus = 60 S
The price 130
rises to $120. 120
Price floor
110
Buyers
100
demand
60 rooms, 90

sellers supply 80 D
120, causing 70
a surplus. 60
50
40
0 Q
50 60 70 80 90 100 110 120 130
16
 TAXATION

SUPPLY, DEMAND, AND GOVERNMENT POLICIES 17

 A Tax on Buyers
The price buyers
Tax reduces the pay $1,50 tax
is now $1.50 higher than
demand.
the market price P. P
If net price does not got S1
lowerd, demand will be
reduced $10.00
Tax

$8.50
D1
D2
Q
500

SUPPLY, DEMAND, AND GOVERNMENT POLICIES 18

 A Tax on Buyers
A tax on
buyers shifts Effects of a $1.50 per
unit tax on buyers
the D curve P
down by the
S1
amount of PB = $11.00
Tax
the tax.
$10.00
PS = $9.50
The price
buyers pay
D1
rises, the
price sellers D2
Q
receive falls, 430 500
eq’m Q falls.
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
 The Incidence of a Tax:
how the burden of a tax is shared among
market participants
P
Because
of the tax, S1
PB = $11.00
Tax
buyers pay
$10.00
$1.00 more,
PS = $9.50
sellers get
$0.50 less. D1
D2
Q
430 500

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

 A Tax on Sellers
$1.50 tax
Supplier keeps
the net price or P S2
reduces the $11.50
Tax S1
volume.
$10.00

D1

Q
500

SUPPLY, DEMAND, AND GOVERNMENT POLICIES 21

 A Tax on Sellers
A tax on
sellers shifts Effects of a $1.50 per
unit tax on sellers
the S curve P
up by the S2
S1
amount of PB = $11.00
Tax
the tax.
$10.00
PS = $9.50
The price
buyers pay
D1
rises, the
price sellers
Q
receive falls, 430 500
eq’m Q falls.
CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES
 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!

What matters P
is this: S1
PB = $11.00
Tax
A tax drives $10.00
a wedge PS = $9.50
between the
price buyers D1
pay and the
price sellers
Q
receive. 430 500

CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

A C T I V E L E A R N I N G 2:
Effects of a tax The market for
P
140 hotel rooms
Suppose govt S
130
imposes a tax 120
on buyers of 110
$30 per room. 100
90
Find new
80 D
Q, PB, PS,
70
and incidence
60
of tax.
50
40
0 Q
50 60 70 80 90 100 110 120 130
24
A C T I V E L E A R N I N G 2:
Answers The market for
P
140 hotel rooms
S
130
Q = 80
120

PB = $110 PB = 110
100
Tax
PS = $80 90
PS = 80 D
70
Incidence
60
buyers: $10
50
sellers: $20 40
0 Q
50 60 70 80 90 100 110 120 130
25