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Governmental Policy and Supply and Demand

Governmental Policy and Supply and Demand. Price Controls. Price Ceilings Highest legal price of a product or good Binding if below market equilibrium Leads to shortage Non-binding if above Price Floor Lowest legal price of a product or good Binding if above market equilibrium

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Governmental Policy and Supply and Demand

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  1. Governmental PolicyandSupply and Demand

  2. Price Controls • Price Ceilings • Highest legal price of a product or good • Binding if below market equilibrium • Leads to shortage • Non-binding if above • Price Floor • Lowest legal price of a product or good • Binding if above market equilibrium • Leads to surplus • Non-binding if below

  3. Price Ceilings P P D D S S P^ No Effect P^ Shortage S* D* Q Q

  4. Examples: Caution-Using a Model • OPEC limits output, US gov’t places price ceiling on gas • Led to shortage, long lines for gas • Unexpected side effect : small cars boom • NY rent control • Short run (inelastic) vs Long run (more elastic) • SR small shortage, LR large shortage • Other ways around • Key deposits, paying finders fees • Other adverse effects • People less likely to move, inefficient • Lower quality housing (less incentive to keep up)

  5. Price Floors P P D D S S Surplus P_ No Effect P_ D* S* Q Q

  6. Example: Caution-Using a Model • Minimum Wage • 1938 Fair Labor Standards Act • Market • Workers Supply Labor (elastic/inelastic ?) • Employers Demand Labor (elastic/inelastic ?) • Impact • Above equilibrium: surplus (unemployment) • Higher wages for those with jobs • Difference by skills • Skilled Workers unaffected – why? • Unskilled/youth affected – why?

  7. Subsidies and Taxes • Subsidy: get paid to buy or get paid to produce/sell • Give incentive to participate in market • Market increases in size • Tax: have to pay to buy or have to pay to produce/sell • Give disincentive to participate in market • Market decreases in size • For both change in market size depends on combined elasticity of supply demand • More elastic bigger change

  8. Subsidy • Regardless of subsidize buyer or seller • Outcome quantity is the same • Realized buyer/seller price the same • Market price differs by subsidy (also buyer/seller) • Both Gain, but: • Who gains the most from the subsidy (seller or buyer) depends on who’s curve is most inelastic

  9. Outcome P, Q, BP, SP (why shift curves up/down?) Buyer Gets Subsidy Seller Gets Subsidy P P D’ D’’ D’ S’ S’ S’’ Subsidy Subsidy SP=P’’ SP=P’’+S P’ P’ BP=P’’ BP=P’’-S Q’ Q’’ Q Q’ Q’’ Q

  10. Subsidy Wedge View Buyer Gets Subsidy View Seller Gets Subsidy View D’’ D’ S’ D’ S’ D’ S’’ SP Subsidy Wedge P’ BP Q’ Q’’ Q’ Q’’ Q’ Q’’

  11. Who Gains? : Price Effect Supply Curve More Inelastic so Seller Gains More Demand Curve More Inelastic so Buyer Gains More S D’’ D’’ D’ S D’ SP SP P’ BP BP

  12. Effect on Size of Market Very Inelastic So Small Change In Quantity Very Elastic So Large Change In Quantity D’’ S D’ D’’ S D’ Q’ Q’’ Q’ Q’’

  13. Winners/Losers • Winners • Buyers in market • Sellers in market • Losers • Tax payers not in market • Competitors (trading partners)

  14. Examples • Farm Subsidies • Who wins/loses • Rational • Home Buying Subsidies (2 kinds) • Who wins/loses • Rational • Ethanol Subsidies • Who wins/loses • Rational

  15. Taxes • Regardless of taxing buyer or seller • Outcome quantity is the same • Realized buyer/seller price the same • Market price differs by tax (also buyer/seller) • Both Lose, but: • Who loses the most from the tax (seller or buyer) depends on who’s curve is most inelastic • Tax incident

  16. Outcome P, Q, BP, SP (why shift curve down/up?) Buyer Gets Taxed Seller Gets Taxed P P D’’ D’ D’ S’ S’’ S’ Tax Tax BP=P’’+T P’ SP=P’’ BP=P’’ P’ SP=P’’-T Q’’ Q’ Q Q’’ Q’ Q

  17. Who Loses? : Price Effect Supply Curve More Inelastic so Seller Loses More Demand Curve More Inelastic so Buyer Loses More S D’ D’’ Tax S BP BP P’ P’ SP SP D’ Tax D’’

  18. Effect on Size of Market Very Inelastic So Small Change In Quantity Very Elastic So Large Change In Quantity D’ S D’’ D’ S D’’ Q’’ Q’ Q’’ Q’

  19. Winners/Losers • Losers • Buyers in market • Sellers in market • Winners • Recipients of the tax money • Competitors (trading partners)

  20. Examples • Payroll Tax – good is labor supplied by workers demanded by firms • Employee and employer both pay half • True Tax incidence • Depends on elasticity of supply(workers) and demand(firms) • Change in market size • Depends if markets are elastic or inelastic

  21. Example 2 • Luxury tax introduced in 1990 to tax those that can most afford to ‘splurge’ • Luxury demand is elastic • Supply relatively inelastic • Outcome • Most of tax incidence fell on suppliers • So repealed in 1992

  22. Main Points – Subsidies/Taxes • Tax or subsidy “creates” new hypothetical supply/demand curve • Same outcome if put on seller or buyer • Subsidies increase market, taxes reduce it • How much depends how elastic market is • Gain or lose from subsidy/tax split between buyers and sellers • Who gets more or pays more depends on who is more inelastic • Difference between buyer/seller price is the tax or subsidy size

  23. Review of Graphs (Note whose on ‘top’ switches) Subsidy and its incidence Tax and its incidence Seller share of subsidy Buyer share of tax Subsidy Wedge P’ P’ Tax Wedge Buyer share of subsidy Seller share of tax

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