Handout Patrick Toche Free by ihuangpingba

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									         Supply, Demand, and Government Policies

                                   Dr. Patrick Toche




       References :

          † N. Gregory Mankiw, Principles of Economics, South-Western.
          † Paul Krugman and Robin Wells, Economics, Worth Publishers.

       Mankiw’s textbook will be followed closely. Both textbooks come in a more com-
       pact edition containing only the micro chapters. Both textbooks come in a more
       affordable paperback, international edition available in Asia (not authorized for
       sale in the U.S.A or Canada). Both textbooks come with online resources such as
       study guides and quizzes. Other textbooks may be equally suitable, consult me
       for advice. Other references will be given from time to time.




In this chapter you will learn...

       the effects of government policies that place a ceiling on prices
       the effects of government policies that put a floor under prices
       how a tax affects the price of the good and the quantity sold
       taxes levied on buyers and taxes levied on sellers are equivalent
       how the burden of a tax is split between buyers and sellers
Efficiency and Equity

       In a free, unregulated market system, market forces establish
       equilibrium prices and quantities.
       In a perfectly competitive market, equilibrium conditions are
       efficient ...
       ... but efficiency does not imply equity.
       One of the roles of economists is to use their theories to assist
       in the development of policies that strike a balance between
       efficiency and equity.




Price Ceilings

       Price Ceiling :
       A legal maximum on the price at which a good can be sold.
       Two outcomes are possible :
         1. The price ceiling is not binding,
                  if set above the equilibrium price,
                  it then has no effect on the equilibrium.
         2. The price ceiling is binding,
                  if set below the equilibrium price,
                  it then leads to a shortage.
Price Ceilings




   Figure 6-1, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.




Price Ceilings Create ...

         Shortages, because QD > QS .
         Example : gasoline shortages of the 1970s.
         Nonprice rationing.
         Examples : long lines, discrimination, corruption.
Price Ceilings : Case Study

         In 1973, OPEC raised the price of crude oil in world markets.
         Crude oil is the major input in gasoline, so the higher oil prices
         reduced the supply of gasoline.
         What was responsible for the long gas lines ?
         Economists blame government regulations that limited the price
         oil companies could charge for gasoline.




Price Ceilings : Case Study




   Figure 6-2, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.
Price Ceilings : Case Study




   Figure 6-3, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.




Price Ceilings : Case Study

         Rent controls are ceilings placed on the rents that landlords may
         charge their tenants.
         The goal of rent control policy is to help the poor by making
         housing more affordable.
         “The best way to destroy a city ... other than bombing.” (Assar
         Lindbeck c.1972, as quoted by Greg Mankiw)
Price Floors

         Price Floor :
         A legal minimum on the price at which a good can be sold.
         Two outcomes are possible :
            1. The price floor is not binding,
                      if set below the equilibrium price,
                      it then has no effect.
            2. The price floor is binding
                      if set above the equilibrium price,
                      it then leads to a surplus.




Price Floors




   Figure 6-4, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.
Price Floors

       A price floor prevents supply and demand from moving toward
       the equilibrium price and quantity.
       When the market price hits the floor, it can fall no further, and
       the market price equals the floor price.
       Example : Minimum wage laws dictate the lowest price possible
       for labor that any employer may pay.
       The minimum wage is more likely to bind for the unskilled and
       the young.




Price Floors Create ...

       Surpluses because QS > QD .
       Examples : minimum wages, agricultural price supports.
       nonprice rationing.
       Examples : discrimination.
       waste.
       Examples : unemployment, butter mountains.
Price Floors : Case Study




   Figure 6-5, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.




Taxes

         Governments levy taxes to raise revenue for public projects.
         Taxes discourage market activity.
         When a good is taxed, the quantity sold is smaller.
         Buyers and sellers share the tax burden.
Tax On Buyers




   Figure 6-6, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.




Tax On Sellers




   Figure 6-7, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.
Payroll Tax




   Figure 6-8, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.




Elasticity and Tax Incidence

         Taxes result in a change in market equilibrium : Buyers pay
         more and sellers receive less, regardless of whom the tax is
         levied on.
         Taxes discourage market activity : When a good is taxed, the
         quantity bought and sold is smaller.
         Tax incidence is the manner in which the burden of a tax is
         shared among participants in a market.
         The burden of a tax falls more heavily on the side of the market
         that is less elastic.
Elasticity and Tax Incidence




   Figure 6-9, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.




Elasticity and Tax Incidence




   Figure 6-9, Mankiw, Principles of Microeconomics, South-Western College, Fifth Edition, 2009.
Sin Taxes

       Eight out of ten smokers in America say they want to quit their
       habit. But they face a “self-control” problem.
       Consumers with self-control problem have very low demand
       price elasticities.
       Sin taxes such as the cigarette tax try to protect people from
       themselves.
       Sin taxes counteract over-consumption by consumers with
       self-control problems and redistribute income to consumers with
       no self-control problems.




Summary

    1. Price controls include price ceilings and price floors.
    2. A price ceiling is a legal maximum on the price of a good or
       service. An example is rent control.
    3. A price floor is a legal minimum on the price of a good or a
       service. An example is the minimum wage.
Summary

   4. Taxes are used to raise revenue for public purposes.
   5. When the government levies a tax on a good, the equilibrium
      quantity of the good falls.
   6. A tax on a good places a wedge between the price paid by
      buyers and the price received by sellers.




Summary

   7. The incidence of a tax refers to who bears the burden of a tax.
   8. The incidence of a tax does not depend on whether the tax is
      levied on buyers or sellers.
   9. The incidence of the tax depends on the price elasticities of
      supply and demand.
  10. The burden tends to fall on the side of the market that is less
      elastic.
Problems and Applications

   Mankiw, Principles of Micro, Problem 5, Chapter 6.
        A senator wants to raise tax revenue and make workers better
        off. A staff member proposes raising the payroll tax paid by
        firms and using part of the extra revenue to reduce the payroll
        tax paid by workers. Would this accomplish the senator’s goal ?
   Mankiw, Principles of Micro, Problem 6, Chapter 6.
        If the government places a $500 tax on luxury cars, will the
        price paid by consumers rise by more than $500, less than
        $500, or exactly $500 ? Explain.




Problems and Applications

   Mankiw, Principles of Micro, Problem 8, Chapter 6.
        (a) Suppose the minimum wage is above the equilibrium wage in the
        market for unskilled labor. Using a supply-and-demand diagram of the
        market for unskilled labor, show the market wage, the number of
        workers who are employed, and the number of workers who are
        unemployed. Also show the total wage payments to unskilled workers.
        (b) Now suppose the secretary of labor proposes an increase in the
        minimum wage. What effect would this increase have on employment ?
        Does the change in employment depend on the elasticity of demand,
        the elasticity of supply, both elasticities, or neither ?
Problems and Applications

      (c) What effect would this increase in the minimum wage have on
      unemployment ? Does the change in unemployment depend on the
      elasticity of demand, the elasticity of supply, both elasticities, or
      neither ?
      (d) If the demand for unskilled labor were inelastic, would the proposed
      increase in the minimum wage raise or lower total wage payments to
      unskilled workers ? Would your answer change if the demand for
      unskilled labor were elastic ?

								
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