Chapter 6 Supply, Demand and Government Policies

1. Chapter 6Supply, Demand and Government Policies

2. Controls on Prices • Price Ceiling: Legal maximum on the price at which a good can be sold • Price Floor: Legal minimum on the price at which a good can be sold

3. How Price Ceilings affect Market Outcomes • Two outcomes: 1. If price ceiling is higher than or equal to equilibrium price, it is not binding and has no effect on the price or quantity sold

4. How Price Ceilings Affect Market Outcomes 2. If the price ceiling is lower than the equilibrium price, the ceiling is a binding constraint and a shortage is created

5. Results of Binding Price Ceiling • If shortage occurs (and price can’t be adjusted), a method for rationing the good must be developed • Not all buyers benefit from a price ceiling because some will be unable to purchase the product

6. Case Studies • Lines at the Gas Pump • Rent Control in Short Run & Long Run

7. Price Floors • If price floor is lower than or equal to the equilibrium price, it is not binding and has no effect on the price or quantity sold

8. Price Floors • If the price floor is higher than the equilibrium price, the floor is a binding constraint and a surplus is created

9. Case Study • The Minimum Wage

10. Tax Incidence • Who bears the burden of taxation?

11. Taxes on Buyers • Does it affect supply and/or demand? • Demand curve shifts left/down by the amount of the tax Amount = tax

12. Who pays the tax on buyers? • Because market price falls when tax is introduced, sellers receive less than when market worked freely. • Buyers now pay more with the tax, so they are worse off as well. So… taxes discourage market activity (Q drops) and buyers + sellers share burden of taxes.

13. Taxes on Sellers • Does it affect supply or demand? • The Supply curve shifts left/upward by exactly the size of the tax

14. Who pays the tax on sellers? • With upward supply shift, equilibrium quantity will fall and price that buyers pay will go up, but the amount sellers receive after paying the tax will go down. • Thus taxes on buyers and taxes on sellers are equivalent – both buyers & sellers share the burden of the tax

15. Payroll Taxes

16. Elasticity and Tax Incidence • General rule: Tax burden falls more heavily on the side of the market that is less elastic • Therefore, it is not very likely that a tax will be split 50-50

17. Luxury Taxes • Who really pays the tax?

18. Using the graph for market X, what would there be if the gov’t imposed an effective price ceiling? • Shortage of AB • Surplus of AB • Shortage of IH • Surplus of IH • Shortage of GE

19. Using the same graph, what would there be if the gov’t imposed an effective price floor on the market? • Shortage of AB • Surplus of AB • Shortage of IH • Surplus of IH • Shortage of GE

20. A tax on producers will: • Increase demand, causing P & Q to rise • Increase supply, causing P & Q to rise • Decrease supply, causing P to rise & Q to fall • Decrease demand, causing P to rise and Q to fall • Decrease supply, causing both P & Q to fall

21. A tax on consumers will: • Shift supply to the left, raising P & lowering Q • Shift demand to right, raising both P & Q • Shift demand to the left, lowering both P & Q • Shift supply to the right, lowering P & raising Q • Shift demand to the left, lowering P & raising Q

22. The more inelastic the supply curve and the more elastic the demand curve, the: • More of the tax the producer will pay • More of the tax the consumer will pay • More the tax will be split equally between the consumer & producer • Less likely the tax will have an effect on price • None of the above