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Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Repealing the Laws of Supply and Demand:
Price ControlsPrice Ceiling A legally established maximum price at which a
good can be sold.
Price Floor A legally established minimum price at which a
good can be sold.
A Price Ceiling That Is Not Binding...
$4
3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Demand
Supply
Priceceiling
Equilibriumprice
100Equilibrium
quantity
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
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
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The 1970s Energy Crisis: The Price Ceiling on Gasoline
P1
Quantity ofGasoline
0
Price ofGasoline
Q1
Demand
S1
Priceceiling
S2 2. …but when supply falls...
P2
3. …the price ceiling becomes binding...
4. …resulting in a shortage.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Rent Control in the Short Run...
Quantity ofApartments
0
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Supply and demand for apartments
are relatively inelastic
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Rent Control in the Long Run...
Quantity ofApartments
0
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Because the supply and demand for
apartments are more elastic...
…rent control causes a
large shortage
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Minimum Wage: An important example of a price floor …
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Free Labor Market
Quantity ofLabor
0
Wage
Equilibrium
wage
Labor demand
Labor supply
Equilibriumemploymen
t
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Minimumwage
The Minimum Wage
Quantity ofLabor
0
Wage
Labor demand
Labor supply
Quantitysupplied
Quantitydemanded
Labor surplus(unemployment)
A Labor Market with a Minimum Wage
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
What are the equilibrium price and quantity of Frisbees? Frisbee manufacturers persuade the government that Frisbee
production improves scientists’ understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees are sold?
Irate college students march on Washington and demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former price floor. What is the new market price? How many Frisbees are sold?
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Taxes
Governments levy taxes to raise revenue for public
needs.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
What are some potential impacts of taxes?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden.
Impact of a 50¢ Tax Levied on Buyers...
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
100
D1
Supply, S1
A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).
D2
Copyright © 2001 by Harcourt, Inc. All rights reserved
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 on Buyers...
2.80
Pricesellersreceive
Copyright © 2001 by Harcourt, Inc. All rights reserved
Pricewithout
tax
Tax ($0.50)
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
What was the impact of tax? Taxes discourage market
activity. When a good is taxed, the
quantity sold is smaller. Tax puts a wedge between
the price buyers pay and the price sellers receive.
Buyers and sellers share the tax burden.
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
10090
S1
S2
Demand, D1
Impact of a 50¢ Tax on Sellers...
Price without tax
2.80
Price sellers receiv
e
$3.30
Price buyers
pay
Equilibrium without tax
Copyright © 2001 by Harcourt, Inc. All rights reserved
A tax on sellers shifts the supply
curve upward by the
amount of the tax ($0.50).
Tax ($0.50)
Equilibriumwith tax
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
What was the impact of tax? Taxes discourage market
activity. When a good is taxed, the
quantity sold is smaller. Tax puts a wedge between
the price buyers pay and the price sellers receive.
Buyers and sellers share the tax burden.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
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
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
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
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
So, how is the burden of the tax divided?
The burden of a tax falls more heavily on the side of the market that is less elastic.If you can’t easily adjust, you’re stuck paying most of the tax.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Summary
Price controls include price ceilings and price floors.
A price ceiling is a legal maximum on the price of a good or service. An example is rent control.
A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Summary Taxes are used to raise revenue for
public purposes. When the government levies a tax on
a good, the equilibrium quantity of the good falls.
A tax on a good places a wedge between the price paid by buyers and the price received by sellers.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Summary The incidence of a tax refers to who
bears the burden of a tax. The incidence of a tax does not
depend on whether the tax is levied on buyers or sellers.
The incidence of the tax depends on the price elasticities of supply and demand.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Graphical Review
A Price Ceiling That Is Not Binding...
$4
3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Demand
Supply
Priceceiling
Equilibriumprice
100Equilibrium
quantity
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
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
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Price Ceiling on Gasoline Is Not Binding...
$4
P1
Quantity ofGasoline
0
Price ofGasoline
Q1
Demand
Supply
Priceceiling
1. Initially, the price ceiling is not binding...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Price Ceiling on Gasoline Is Binding...
P1
Quantity ofGasoline
0
Price ofGasoline
Q1
Demand
S1
Priceceiling
S2 2. …but when supply falls...
P2
3. …the price ceiling becomes binding...
4. …resulting in a shortage.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Rent Control in the Short Run...
Quantity ofApartments
0
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Supply and demand for apartments
are relatively inelastic
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Rent Control in the Long Run...
Quantity ofApartments
0
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Because the supply and demand for
apartments are more elastic...
…rent control causes a
large shortage
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Floor That Is Not Binding...
$3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
100Equilibrium
quantity
Equilibrium
price
Demand
Supply
Pricefloor2
A Price Floor That Is Binding...
$3
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Equilibrium
price
Demand
Supply
Price floor$4
120Quantitysupplied
80Quantity
demanded
Surplus
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Minimum Wage
Quantity ofLabor
0
Wage
Equilibrium
wage
Labor demand
Labor supply
A Free Labor Market
Equilibriumemploymen
t
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
The Minimum Wage
Minimumwage
Quantity ofLabor
0
Wage
Labor demand
Labor supply
Quantitysupplied
Quantitydemanded
Labor surplus(unemployment)
A Labor Market with a Minimum Wage
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Impact of a 50¢ Tax Levied on Buyers...
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
100
D1
Supply, S1
A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).
D2
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Impact of a 50¢ Tax Levied on Buyers...
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
2.80
Pricesellersreceive
Pricewithout
tax
Tax ($0.50)
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Impact of a 50¢ Tax on Sellers...
3.00
Quantity ofIce-Cream Cones
0
Price ofIce-Cream
Cone
10090
S1
S2
Demand, D1
Price without tax
2.80
Price sellers receiv
e
$3.30
Price buyers
pay
Equilibrium without tax
A tax on sellers shifts the supply
curve upward by the
amount of the tax ($0.50).
Tax ($0.50)
Equilibriumwith tax
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Payroll Tax
Quantity ofLabor
0
Wage
Wage without
tax
Labor demand
Labor supply
Tax wedge
Wage firms pay
Wage workers receive
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
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
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
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