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LECTURE
5 In this chapter,
look for the answers to these questions:
Supply, Demand, and What are price ceilings and price floors?
Government Policies 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?
1
Government Policies That Alter the EXAMPLE 1: The Market for Apartments
Private Market Outcome
Price controls P
Price ceiling: a legal maximum on the price Rental S
price of
of a good or service Example: rent control
apts
Price floor: a legal minimum on the price of
a good or service Example: minimum wage $800
Eqm w/o
Taxes
price
The govt can make buyers or sellers pay a
controls
specific amount on each unit bought/sold.
D
Q
We will use the supply/demand model to see 300
how each policy affects the market outcome Quantity of
(the price buyers pay, the price sellers receive, apartments
and eqm quantity).
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 2 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 3
How Price Ceilings Affect Market Outcomes How Price Ceilings Affect Market Outcomes
A price ceiling P The eqm price P
above the S S
Price ($800) is above
eqm price is $1000 the ceiling and
ceiling
not binding therefore illegal.
has no effect $800 $800
The ceiling
on the market
is a binding Price
outcome. $500
constraint ceiling
on the price, shortage
D D
Q causes a Q
300 250 400
shortage.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 4 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 5
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EXAMPLE 2: The Market for Unskilled Labor How Price Floors Affect Market Outcomes
W A price floor W
Wage S below the S
paid to
eqm price is
unskilled
workers not binding
$4 has no effect $4
Eqm w/o on the market
Price
outcome. $3
price floor
controls
D D
L L
500 500
Quantity of
unskilled workers
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 8 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 9
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ACTIVE LEARNING 1 The market for ACTIVE LEARNING 1 The market for
B. $90 price floor hotel rooms in Boracay C. $120 price floor hotel rooms in Boracay
P
140 The price P
140
Eqm price is S surplus = 60 S
130 rises to $120. 130
above the floor,
120 120
so floor is not Buyers Price floor
110 110
binding. demand
100 100
P = $100, 60 rooms,
90 90
Q = 100 rooms. Price floor sellers supply
80 D 80 D
120, causing a
70 70
surplus.
60 60
50 50
40 40
0 Q 0 Q
50 60 70 80 90 100 110 120 130
14 50 60 70 80 90 100 110 120 130
15
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 16 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 17
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES 18 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 19
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 20 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 21
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 22 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 23
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Elasticity and Tax Incidence CASE STUDY: Who Pays the Luxury Tax?
CASE 2: Demand is more elastic than supply 1990: Congress adopted a luxury tax on yachts,
Its easier private airplanes, furs, expensive cars, etc.
P
S for buyers Goal of the tax: raise revenue from those
Buyers share than sellers who could most easily afford to pay
of tax burden PB to leave the
wealthy consumers.
market.
Price if no tax
Tax Sellers bear But who really pays this tax?
Sellers share most of the
of tax burden PS burden of
D the tax.
Q
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 28 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 29
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CASE STUDY: Who Pays the Luxury Tax? CONCLUSION: Government Policies and
the Allocation of Resources
The market for yachts Demand is Each of the policies in this chapter affects the
price-elastic. allocation of societys resources.
P
S
In the short run, Example 1: A tax on pizza reduces eqm Q.
Buyers share
of tax burden PB supply is inelastic. With less production of pizza, resources
(workers, ovens, cheese) will become available
Tax Hence, to other industries.
companies
Sellers share
that build Example 2: A binding minimum wage causes
of tax burden PS a surplus of workers, a waste of resources.
D yachts pay
most of So, its important for policymakers to apply such
Q the tax.
policies very carefully.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES 30 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 31
A price ceiling is a legal maximum on the price of a A tax on a good places a wedge between the price
good. An example is rent control. If the price buyers pay and the price sellers receive, and
ceiling is below the eqm price, it is binding and causes the eqm quantity to fall, whether the tax is
causes a shortage. imposed on buyers or sellers.
A price floor is a legal minimum on the price of a The incidence of a tax is the division of the burden
good. An example is the minimum wage. If the of the tax between buyers and sellers, and does
price floor is above the eqm price, it is binding not depend on whether the tax is imposed on
and causes a surplus. The labor surplus caused buyers or sellers.
by the minimum wage is unemployment. The incidence of the tax depends on the price
elasticities of supply and demand.
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