AP EconomicsCHAPTER 6 – Supply,

Demand and Governmental Policies

9/15/2014

Reading Assignment – Read pages 114 – 131 (Quiz on Thursday)

Bellwork: What happens equilibrium price in a market in equilibrium if the

supply increases?

ANSWER

• The supply increase lowers the equilibrium price!

Controls on Prices

• Two types: • Price Ceiling A legal maximum on the price at which a good can

be sold

• Price Floor A legal minimum on the price at which a good can be sold

Price Ceiling

Say in the country of Ashmoria, an ice cream cone costs $5 but, in their benevolence, the government of Ashmoria decides that no-one can charge more than $3 for an ice cream cone, what happens?

• Because the $3 price is below the equilibrium price of $5, the quantity supplied will be less than the quantity demanded.

• This causes a supply shortage because there are not enough ice cream cones to sell to a very willing public

• This causes a need for rationing because everyone cannot have ice cream cones. This causes long lines to develop in order to buy ice cream at a first come first serve mentality

Conclusion

• When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers.

Rationing mechanisms

1. Long lines Nobody likes waiting in lines

2. Discrimination Never a good idea

Your Turn

• The government tells movie theatres that they can only sell tickets for $5. Analyze what will happen in the market for movie tickets!

1970s long lines at the gas pump

• 1973 The Organization of Petroleum Exporting Countries (OPEC) raised the price of crude oil in world oil markets.• This caused a decrease in the supply of gasoline because gas is a

by-product of refined oil.

• Normally, this would have just resulted in an decrease in the supply of gas in the United States with the price of gas increasing.

• What actually happened was….

What happened

• There were governmental regulations in place to prevent gas prices from increasing to an unacceptable level.

• So, even though the supply of gas had decreased, gas stations had to sell the oil at a price below the equilibrium price. This resulted in a shortage because the quantity supplied was so much less than the quantity demanded.

• Let me draw it out for you!

Quiz

• What does a price ceiling cause?

ANSWER

• A shortage

Rent Control

• Many millions of people across the country pay rent for the house or apartment they inhabit. RENT CONTROLS are when the government requires the landlords of said apartments to only charge a certain amount in order to allow lower-income individuals access to affordable housing.

• Two different ways to look at this:• Short-Term (Short run)• Long-Term (Long-run)

Short Run influence of Rent Controls

• Supply and Demand are inelastic. • There are only a fixed number of apartments to rent.

• People searching for housing in a city don’t really care about rent changes in the short run because they are adjusting to their housing arrangements.

• At a fixed ceiling price, the shortage that occurs in the short run is relatively small.

• Let me show you!

Long-Term influence of Rent Controls

• Supply and Demand are both elastic. People respond more to market conditions as time passes.

• Supply-side : Landlords build less new apartments and by failing to maintain existing ones.• They do this because the long lines of people waiting to get a new

apartment, if someone is unhappy with the state of their apartment, there is always someone else to take that individual’s spot.

• Demand-side : Low rents entice people to find their own apartments rather than live with their parents and promote living in a city.

• Let me show you what the shortage looks like now.

Critics of Rent Controls

• Rent Controls lead to a lower standard of living within the cities because landlords cannot fix up or sell really nice new apartments at a higher price to reflect the work put into making them that way.• We get a bunch of poorly maintained apartments within the cities

• Trying to enforce laws that would require landlords to keep their apartments nice is usually to costly to attempt.

• In a free market, there are always those willing to pay more for a nicer apartment and the cheap apartments will always exist.

Minimum Wage

• You analyze what will happen using the market for labor…I will show you what that looks like.

• What happens to the Labor market when the minimum wage is raised?

TAXES

• Taxes can be thought of as another form of price control.

• Important question to ask yourself...

• When the government puts a tax on a good, who actually bears the burden of the tax?• Is it the people who buy it? Or the people who sell it?

• Economists call the distribution of the tax burden TAX INCIDENCE

Example