chapter-2 (c) demand-supply ang government policies (1)

8/17/2019 Chapter-2 (c) Demand-Supply Ang Government Policies (1)

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Supply, Demand, andGovernment Policies

Delivered by:Dr. Faisal Khan



In this chapter,

look for the answers to these

questions:• What are price ceilins and price !oors"

What are some e#amples of each"

•

$ow do price ceilins and price !oorsa%ect market outcomes"

• $ow do ta#es a%ect market outcomes"$ow do the e%ects depend on whetherthe ta# is imposed on buyers or sellers"

• What is the incidence of a ta#"What determines the incidence"

&



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

3

Government Policies 1hat lter thePrivate +arket .utcome

• Price controls

– Price ceiling: a leal ma#imum on thepriceof a ood or service Example: rent control

– Price foor: a leal minimum on the priceofa ood or service Example: minimumwage

•

1a#es – 1he ovt can make buyers or sellers pay a

speci4c amount on each unit bouht5sold6

We will use the supply5demand model to

see

how each policy a%ects the market

outcome

We will use the supply5demand model to

see

how each policy a%ects the market

outcome



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

*;+P(* <: 1he +arket for partments

*q8m w5oprice

controls

*q8m w5oprice

controls

P

QD

S0entalprice

ofapts

=>??

3??

@uantityof

apartments



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

A

$ow Price 2eilins %ect +arket .utcomes

price ceilin

above theeq8m price isnot binding B

has no e%ecton the marketoutcome6

P

QD

S

=>??

3??

Priceceilin

=<???



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

C


1he eq8mprice 7=>??9 isabove theceilin andthereforeilleal6

1he ceilinis a bindingconstraint on the price,causes ashortae6

P

QD

S

=>??

Priceceilin

=A??

&A? ??

shortag

e



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S


In the lonrun, supplyand demandare more

priceEelastic6So, theshortaeis larer6

P

QD

S

=>??

<A?

Priceceilin

=A??

A?

shortag

e



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

>

Shortaes and 0ationin

• With a shortae, sellers must ration the

oods amon buyers6• Some rationin mechanisms: 7<9 (on lines

7&9 Discrimination accordin to sellers8 biases

•

1hese mechanisms are often unfair, andineFcient: the oods do not necessarily oto the buyers who value them most hihly6

• In contrast, when prices are not controlled,

the rationin mechanism is eFcient 7theoodso to the buyers that value them mosthihly9

and impersonal 7and thus fair96



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

*;+P(* &: 1he +arket for 'nskilled (abor

*q8m w5oprice

controls

*q8m w5oprice

controls

W

LD

SWaepaid tounskille

d

workers

=

A??

@uantity ofunskilled

workers



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

<?

$ow Price Hloors %ect +arket .utcomes

W

LD

S

=

A??

Price!oor

=3

price !oor

below theeq8m price isnot binding B

has no e%ecton the marketoutcome6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

<<

$ow Price Hloors %ect +arket .utcomes

W

LD

S

=

Price!oor

=A

1he eq8m wae7=9 is below the!oor andthereforeilleal6

1he !ooris a bindingconstraint on the wae,causes asurplus 7i.e., unemployment96

?? AA?

labor

surplus



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

<&

+in wae laws

do not a%ecthihly skilledworkers6

1hey do a%ect

teen workers6

Studies: <? increase

in the minwae raisesteenunemployment

1he +inimum Wae

W

LD

S

=

+in6wae

=A

?? AA?

unemp-

loyment



2 1 I / * ( * 0 - I - G 1

Price controls

Q

P S

?

1he market for

hotel rooms

D

Determinee%ects of:

A6 =?priceceilin

B6 =? price!oor

C. =<&?price

!oor <3



2 1 I / * ( * 0 - I - G 1

6 =? price ceilin

Q

P S

?

1he market for

hotel rooms

D

1he price

falls to =?6

Juyers

demand<&? rooms,

sellers

supply ?,

leavin ashortae6

shortage K

3?

Priceceiling

<



2 1 I / * ( * 0 - I - G 1

J6 =? price !oor

Q

P S

?

1he market for

hotel rooms

D

*q8m price is

above the

!oor, so !oor

is not bindin6

P K =<??,

Q K <??

rooms6

Price foor

<A



2 1 I / * ( * 0 - I - G 1

26 =<&? price !oor

Q

P S

?

1he market for

hotel rooms

D

1he pricerises to

=<&?6

Juyersdemand

C? rooms,

sellers

supply <&?,causin a

surplus6

surplus KC?

Price foor

<C



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

<

*valuatin Price 2ontrols• 0ecall one of the 1en Principles from

2hapter <:Markets are usually a good wayto organize economic activity.

Prices are the sinals that uide the

allocation of society8s resources6 1hisallocation is altered when policymakers

restrict prices6

Price controls often intended to help the

poor,

but often hurt more than help6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

<>

1a#es• 1he ovt levies ta#es on many oods

L services to raise revenue to pay fornational defense, public schools, etc6

•

1he ovt can make buyers or sellerspay the ta#6

• 1he ta# can be a of the ood8s

price,or a speci4c amount for each unitsold6 – Hor simplicity, we analyMe perEunit ta#es

only6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

<

S1

*;+P(* 3: 1he +arket for PiMMa

*q8mw5ota#

*q8mw5ota#

P

Q

D1

=<?6??

A??



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&?

S1

D1

=<?6??

A??

1a# on Juyers

1he price buyers pay

is now =<6A? hiherthan the market priceP6

P would have to fall

by =<6A? to makebuyers willinto buy same Q as before6

E.g., if P fallsfrom =<?6?? to =>6A?,buyers still willin topurchase A?? piMMas6

P

QD2

*%ects of a =<6A?

per unit ta# onbuyers

=>6A?

$ence, a ta# on

buyers shifts the D curve down by the

amount of the ta#6

$ence, a ta# on

buyers shifts the D curve down by the

amount of the ta#6

1a#



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&<

S1

D1

=<?6??

A??

1a# on Juyers

P

QD2

=<<6??PB

K=6A

?PS

K

1a#

*%ects of a =<6A?

per unit ta# onbuyers

-ew eq8m:

Q K A?

Sellers

receive

PS K =6A?Juyers pay

PB K =<<6??

Di%erencebetween them

K =<6A? K ta# A?



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&&

A?

S1

1he Incidence of a 1a#:how the burden of a ta# is sharedamonmarket participants P

Q

D1

=<?6??

A??

D2

=<<6??PB

K=6A

?PS

K

1a#

In our

e#ample,

buyerspay

=<6??

more,

sellers et

=?6A? less6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&3

S1

1a# on Sellers

P

Q

D1

=<?6??

A??

S2

*%ects of a =<6A?

per unit ta# onsellers

1he ta# e%ectively

raises sellers8 costs by

=<6A? per piMMa6

Sellers will supply

A?? piMMasonly if

P rises to =<<6A?,

to compensate for

this cost increase6

=<<6A?

$ence, a ta# on sellers shifts the

S curve up by the amount of the

ta#6

$ence, a ta# on sellers shifts the

S curve up by the amount of the

ta#6

1a#



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&

S1

1a# on Sellers

P

Q

D1

=<?6??

A??

S2

A?

=<<6??PB

K=6A

?PS

K

1a#

*%ects of a =<6A?

per unit ta# onsellers

-ew eq8m:

Q K A?

Juyers pay

PB K =<<6??

Sellersreceive

PS K =6A?

Di%erencebetween them

K =<6A? K ta#



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&A

S1

1he .utcome Is the Same in Joth 2ases

Whatmatters isthis:

ta# drives

a wedebetween

the pricebuyers payand theprice sellers

receive6

P

Q

D1

=<?6??

A??A?

=6A?

=<<6??PB

KPS

K

1a#

1he e%ects on P and Q, and the ta# incidence

are the same whether the ta# is imposed on

buyers or sellersN



2 1 I / * ( * 0 - I - G !

*%ects of a ta#

Q

P S

?

1he market for

hotel rooms

D

Suppose ovt

imposes a ta#

on buyers of

=3? per room6Hind new

Q, PB, PS,

and incidenceof ta#6



2 1 I / * ( * 0 - I - G !

nswers

Q

P S

?

1he market for

hotel rooms

D

Q K >?

PB K

=<<?PS K =>?

Incidence

buyers:

=<?

sellers:

=&?

1a#

PB

K

PS

K



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&>

*lasticity and 1a# Incidence2S* <: Supply is more elastic than

demandP

Q

D

S

1a#

Juyers8 share

of ta# burden

Sellers8 share

of ta# burden

Price if nota#

PB

PS

It8s easier

for sellers

than

buyers toleave the

market6

So buyers

bear mostof the

burden

of the ta#6

It8s easier

for sellers

than

buyers toleave the

market6

So buyers

bear mostof the

burden

of the ta#6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

&

*lasticity and 1a# Incidence2S* &: Demand is more elastic than

supplyP

Q

D

S

1a#

Juyers8 share

of ta# burden

Sellers8 share

of ta# burden

Price if nota#

PB

PS

It8s easier

for buyers

than

sellers toleave the

market6

Sellers

bear mostof the

burden of

the ta#6

It8s easier

for buyers

than

sellers toleave the

market6

Sellers

bear mostof the

burden of

the ta#6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

3?

2S* S1'D): Who Pays the (u#ury 1a#"• <?: 2onress adopted a lu#ury ta#

on yachts, private airplanes, furs,e#pensive cars, etc6

• Goal of the ta#: raise revenue from

thosewho could most easily a%ord to pay Bwealthy consumers6

• Jut who really pays this ta#"



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

3<

2S* S1'D): Who Pays the (u#ury 1a#"

1he market foryachts

P

Q

D

S

1a#

Juyers8 share

of ta# burden

Sellers8 share

of ta# burden

PB

PS

Demand ispriceEelastic6

Demand ispriceEelastic6

In the short run,supply isinelastic6

In the short run,supply is

inelastic6$ence,companies that

buildyachtspay mostof

the ta#6

$ence,companies that

buildyachtspay mostof

the ta#6



S'PP(), D*+-D, -DG./*0-+*-1 P.(I2I*S

3&

2.-2('SI.-: Government Policies and the llocation of 0esources

•

*ach of the policies in this chapter a%ectsthe allocation of society8s resources6

– Example 1: ta# on piMMa reduces eq8m

Q6

With less production of piMMa, resources7workers, ovens, cheese9 will becomeavailable to other industries6

– Example !: bindin minimum waecauses

a surplus of workers, a waste of

resources6

• So, it8s im ortant for olic makers to a l



2$P1*0 S'++0)

• price ceilin is a leal ma#imum on theprice of a ood6 n e#ample is rent control6If the price ceilin is below the eq8m price, it

is bindin and causes a shortae6

• price !oor is a leal minimum on the priceof a ood6 n e#ample is the minimum

wae6 If the price !oor is above the eq8mprice, it is bindinand causes a surplus6 1he labor surpluscaused by the minimum wae is

unemployment6 33



2$P1*0 S'++0)

• ta# on a ood places a wede between theprice buyers pay and the price sellersreceive, and causes the eq8m quantity to

fall, whether the ta# is imposed on buyers orsellers6

• 1he incidence of a ta# is the division of the

burden of the ta# between buyers andsellers, and does not depend on whether theta# is imposed on buyers or sellers6

• 1he incidence of the ta# depends on the

price elasticities of supply and demand 3

chapter-2 (c) demand-supply ang government policies (1)

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