supply, demand and government policies - windward ... demand, and government policies uin a free,...

1

Supply, Demand andGovernment Policies

Chapter 6

Copyright © 2001 by Harcourt, Inc.

All rights reserved. Requests for permission to make copies of any part of thework should be mailed to:

Permissions Department, Harcourt College Publishers,6277 Sea Harbor Drive, Orlando, Florida 32887-6777.

Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

Supply, Demand, andGovernment Policies

u In a free, unregulated market system,market forces establish equilibrium pricesand exchange quantities.

u One of the things government can do is toset price controls when the market price isseen as unfair to either buyers or sellers.


Price Ceilings & Price Floors

Price Ceilingu A legally established maximum price at which

a good can be sold. (Rent Controls)

Price Flooru A legally established minimum price at which a

good can be sold. (Price Supports forAgriculture)

2


Price Ceilings

Two outcomes are possible when thegovernment imposes a price ceiling:

u The price ceiling is not binding if set abovethe equilibrium price.

u The price ceiling is binding if set below theequilibrium price, leading to a shortage.

u Binding means that there is an economicimpact.

A Price Ceiling That Is Binding...

$3

Quantity ofIce-Cream

Cones

0

Price ofIce-Cream

Cone

2

Demand

Supply

Equilibriumprice

Priceceiling

Shortage

125Quantity

demanded

75Quantitysupplied


A Price Ceiling That Is Not Binding...

$4

3


Cones

0

Price ofIce-Cream

Cone

Demand

Supply

Priceceiling

Equilibriumprice

100Equilibrium

quantity


3


Effects of Price Ceilings

A binding price ceiling creates ...º shortages because QD > QS.

u Example: Gasoline shortage of the1970s

º nonprice rationingu Examples: Long lines, Discrimination

by sellers


The Price Ceiling on Gasoline IsNot Binding...

$4

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

Supply

Priceceiling

1. Initially,theprice ceilingis notbinding...


The Price Ceiling on Gasoline IsBinding...

P1

Quantity ofGasoline

0

Price ofGasoline

Q1

Demand

S1

Priceceiling

S2 2. …butwhen supplyfalls...

P2

3. …the priceceiling becomesbinding...4. …resulting

in a shortage.

4


Rent Controlu Rent controls are ceilings placed on the

rents that landlords may charge theirtenants.

u Rent control can make housing moreaffordable.

u With a price ceiling, you cannot goabove the ceiling.

u But what about the landlords?


Rent Control in the Short Run...

Quantity ofApartments

0

RentalPrice of

Apartment

Demand

Supply

Controlled rent

Shortage

Supply anddemand forapartments

are relativelyinelastic-Whyis the supply

curve vertical?


Rent Control in the Long Run...

Quantity ofApartments

0

RentalPrice of

Apartment

Demand

Supply

Controlled rent

Shortage

Because the supplyand demand forapartments are

more elastic... Whathappens in the long

run?

…rent controlcauses a large

shortage

5


Price Floors

When the government imposes aprice floor, two outcomes arepossible.

u The price floor is not binding if set belowthe equilibrium price.

u The price floor is binding if set above theequilibrium price, leading to a surplus.

u Think of price floors as not being able to gobelow the floor.


A Price Floor That Is Not Binding...

$3


Cones

0

Price ofIce-Cream

Cone

100Equilibrium

quantity

Equilibriumprice

Demand

Supply

Pricefloor2

A Price Floor That Is Binding...

$3


Cones

0

Price ofIce-Cream

Cone

Equilibriumprice

Demand

Supply

Price floor$4

120Quantitysupplied

80Quantity

demanded

Surplus


6


Effects of a Price Floor

A binding price floor causes . . .º a surplus because QS >QD.º nonprice rationing is an alternativemechanism for rationing the good,using discrimination criteria.

uExamples: The minimum wage, Agriculturalprice supports

uState Minimum Wages


The Minimum Wage

Quantity ofLabor

0

Wage

Equilibriumwage

Labor demand

Labor supply

A Free Labor Market

Equilibriumemployment


Minimumwage

The Minimum Wage

Quantity ofLabor

0

Wage

Labor demand

Labor supply

Quantitysupplied

Quantitydemanded

Labor surplus(unemployment)

A Labor Market with aMinimum Wage

7


What are some potentialimpacts of taxes?

u Taxes are used to raisemoney for thegovernment.

u Taxes discourage marketactivity.

u When a good is taxed, thequantity sold is smaller.

u Buyers and sellers sharethe tax burden.

u But who bears theburden-tax incidence.

3.00

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

10090

$3.30

Pricebuyers

pay

D1

D2

Equilibriumwith tax

Supply, S1

Equilibrium without tax

Impact of a 50¢ Tax Levied onBuyers...

2.80

Pricesellersreceive

Copyright © 2001 by Harcourt, Inc. All rights reserved

Pricewithout

tax

Tax ($0.50)

3.00

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

10090

S1

S2

Demand, D1

Impact of a 50¢ Tax on Sellers...

Pricewithout

tax2.80

Pricesellersreceive

$3.30

Pricebuyers

pay

Equilibrium without tax

Copyright © 2001 by Harcourt, Inc. All rights reserved

A tax on sellersshifts the

supply curveupward by theamount of thetax ($0.50). Tax ($0.50)

Equilibriumwith tax

8


The Incidence of Tax

uIn what proportions is the burden ofthe tax divided?

uHow do the effects of taxes on sellerscompare to those levied on buyers?

The answers to these questionsdepend on the elasticity of demand

and the elasticity of supply.


Elastic Supply, Inelastic Demand...

Quantity0

Price

Demand

Supply

Tax

1. When supply is moreelastic than demand...

2. ...theincidence of thetax falls moreheavily onconsumers...

3. ...than onproducers.

Price without tax

Price buyers pay

Price sellers receive


Inelastic Supply, Elastic Demand...

Quantity0

Price

Demand

Supply

Price without tax

Tax

1. When demand is moreelastic than supply...

2. ...theincidence of the tax falls more heavily on producers...

3. ...than on consumers.

Price buyers pay

Price sellers receive

supply, demand and government policies - windward ... demand, and government policies uin a free,...

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