Supply, Demand, and Government Policies. In this chapter, look for the answers to these questions:

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1 6 upply, emand, and Government olicies R I N C I L E O F ECONOMIC FOURTH EITION N. GREGORY MANKIW oweroint lides by Ron Cronovich 26 Thomson outh-western, all rights reserved In this chapter, look for the answers to these questions: What are price ceilings and price floors? What are some examples of each? How do price ceilings and price floors affect market outcomes? How do taxes affect market outcomes? How does the outcome depend on whether the tax is imposed on buyers or sellers? What is the incidence of a tax? What determines the incidence? CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 1 Government policies that alter the private market outcome rice controls rice ceiling: rice floor: Taxes The govt can make buyers or sellers pay a specific amount on each unit bought/sold. We will use the supply/demand model to see how each policy affects the market outcome (the price buyers pay, the price sellers receive, and eq m quantity). 1

2 EXAMLE 1: apartments Rental price of apts Eq m w/o price controls $8 3 uantity of apartments CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 3 How price ceilings affect market outcomes A price ceiling above the eq m price $8 3 CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 4 How price ceilings affect market outcomes The eq m price ($8) is The ceiling is a $8 CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 5 2

3 How price ceilings affect market outcomes In the long run, supply and demand are more price-elastic. $8 CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 6 hortages and rationing With a shortage, sellers must ration the goods among buyers. ome rationing mechanisms: These mechanisms are often unfair, and inefficient: In contrast, when prices are not controlled, the rationing mechanism is CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 7 EXAMLE 2: unskilled labor Wage paid to unskilled workers Eq m w/o price controls $4 W 5 L uantity of unskilled workers CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 8 3

4 How price floors affect market outcomes A price floor below the eq m price $4 W 5 L CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 9 How price floors affect market outcomes The eq m wage ($4) is W The floor is $4 L CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 1 Min wage laws do not affect highly skilled workers. They do affect teen workers. tudies: The minimum wage $4 W L CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 11 4

5 A C T I V E L E A R N I N G 1: rice floors & ceilings 14 etermine effects of: A. $9 price ceiling B. $9 price floor C. $12 price floor A C T I V E L E A R N I N G 1: A. $9 price ceiling A C T I V E L E A R N I N G 1: B. $9 price floor

6 A C T I V E L E A R N I N G 1: C. $12 price floor Evaluating price controls Recall one of the Ten rinciples: Markets are usually a good way to organize economic activity. rice controls are often intended to help the poor, but they often hurt more than help them: CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 16 TAXE The govt levies taxes on many goods & services to raise revenue to pay for national defense, public schools, etc. The govt can make buyers or sellers pay the tax. The tax can be a percentage of the good s price, or a specific amount for each unit sold. For simplicity, we analyze per-unit taxes only. CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 17 6

7 EXAMLE 3: pizza Eq m w/o tax 1 $ CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 18 A tax on buyers Effects of a $1.5 per unit tax on buyers 1 $ CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 19 The Incidence of a Tax: CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 2 7

8 A tax on sellers Effects of a $1.5 per unit tax on sellers 1 $ CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 21 The outcome is CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 22 A C T I V E L E A R N I N G 2: Effects of a tax 14 uppose govt 13 imposes a tax 12 on buyers of 11 $3 per room. 1 Find new, B,, and incidence of tax

9 A C T I V E L E A R N I N G 2: Answers Elasticity and tax incidence CAE 1: upply is more elastic than demand rice if no tax CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 25 Elasticity and tax incidence CAE 2: emand is more elastic than supply rice if no tax CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 26 9

10 Elasticity and tax incidence If buyers price elasticity > sellers price elasticity, If sellers price elasticity > buyers price elasticity, the reverse is true. CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 27 CAE TUY: Who pays the luxury tax? 199: Congress adopted a luxury tax on yachts, private airplanes, furs, expensive cars, etc. Goal of the tax: to raise revenue from those who could most easily afford to pay wealthy consumers. But who really pays this tax? CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 28 CAE TUY: Who pays the luxury tax? yachts emand is price-elastic. In the short run, supply is inelastic. CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 29 1

11 CONCLUION: Government policies and the allocation of resources Each of the policies in this chapter affects the allocation of society s resources. o, it s important for policymakers to apply such policies very carefully. CHATER 6 ULY, EMAN, AN GOVERNMENT OLICIE 3 11