Chapter 6Chapter 6Chapter 6Chapter 6
Supply, Demand, and Government
Policies
Supply, Demand, and Government
Policies
2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited2002 by Nelson, a division of Thomson Canada Limited
Chapter 6: Page 2
• Examine the effects of government policies that place a ceiling on prices.
• Examine the effects of government policies that place a floor under prices.
• Consider how a tax on a good affects the price of the good and the quantity sold.
• Learn that taxes levied on buyers and taxes levied on sellers are equivalent.
• See how the burden of a tax is split between buyers and sellers.
• Examine the effects of government policies that place a ceiling on prices.
• Examine the effects of government policies that place a floor under prices.
• Consider how a tax on a good affects the price of the good and the quantity sold.
• Learn that taxes levied on buyers and taxes levied on sellers are equivalent.
• See how the burden of a tax is split between buyers and sellers.
In this chapter you will…In this chapter you will…In this chapter you will…In this chapter you will…
Chapter 6: Page 3
• In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
• While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
• Hence…market controls!• One of the roles of economists is to use
their theories to assist in the development of policies.
• In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
• While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
• Hence…market controls!• One of the roles of economists is to use
their theories to assist in the development of policies.
SUPPLY, DEMAND, AND SUPPLY, DEMAND, AND GOVERNMENT POLICIES GOVERNMENT POLICIES SUPPLY, DEMAND, AND SUPPLY, DEMAND, AND
GOVERNMENT POLICIES GOVERNMENT POLICIES
Chapter 6: Page 4
• Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
• Result in government-created price ceilings and floors.
• Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
• Result in government-created price ceilings and floors.
CONTROLS ON PRICES CONTROLS ON PRICES CONTROLS ON PRICES CONTROLS ON PRICES
Chapter 6: Page 5
• 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
– 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 Ceilings and Price FloorsPrice Ceilings and Price FloorsPrice Ceilings and Price FloorsPrice Ceilings and Price Floors
Chapter 6: Page 6
• When the government imposes a price ceiling (i.e... a legal maximum on the price at which a good can be sold) two outcomes are possible
1) The price ceiling is not binding.
2) The price ceiling is a binding constraint on the market, creating Shortages.
• When the government imposes a price ceiling (i.e... a legal maximum on the price at which a good can be sold) two outcomes are possible
1) The price ceiling is not binding.
2) The price ceiling is a binding constraint on the market, creating Shortages.
How Price Ceiling Affect Market How Price Ceiling Affect Market OutcomesOutcomes
How Price Ceiling Affect Market How Price Ceiling Affect Market OutcomesOutcomes
Chapter 6: Page 7
Quantity of Ice-Cream
Cones
Price of Ice-Cream
Cone
Demand
Supply
Equilibrium price
$3
(a) A Price Ceiling That is Not Binding (b) A Price Ceiling That is Binding
$4Price
ceiling
Quantity of Ice-Cream
Cones
100Equilibrium
quantity
Price of Ice-Cream
Cone
Demand
Supply
$2
Price ceiling
$3
75
QS
Equilibrium price
125
QD
Shortage
0 0
Figure 6-1: A Market with a Price CeilingFigure 6-1: A Market with a Price CeilingFigure 6-1: A Market with a Price CeilingFigure 6-1: A Market with a Price Ceiling
Chapter 6: Page 8
• A binding price ceiling creates
– Shortages because QD > QS.• Examples: Gasoline shortage of the
1970s, housing shortages with rent controls.
– Non-price rationing• Examples: Long lines, discrimination by
sellers, black markets.
• A binding price ceiling creates
– Shortages because QD > QS.• Examples: Gasoline shortage of the
1970s, housing shortages with rent controls.
– Non-price rationing• Examples: Long lines, discrimination by
sellers, black markets.
How Price Ceiling Affect Market How Price Ceiling Affect Market OutcomesOutcomes
How Price Ceiling Affect Market How Price Ceiling Affect Market OutcomesOutcomes
Chapter 6: Page 9
• 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.
• 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.
CASE STUDY:CASE STUDY: Lines at the Gas PumpLines at the Gas PumpCASE STUDY:CASE STUDY: Lines at the Gas PumpLines at the Gas Pump
Chapter 6: Page 10
Quantity of Gasoline
Price of Gasoline
Demand
S1
(a) A Price Ceiling on Gasoline is Not Binding (b) A Price Ceiling on Gasoline is Binding
Price ceiling
P1
Q10 0
1. Initially the price ceiling is not binding…
Quantity of Gasoline
Demand
S1
Price ceiling
S2
P1
Q1QDQS
P2
4.…resulting in a shortage…
2.…but when supply falls…
3.…the price ceiling becomes binding…
Figure 6-2: A Market for Gasoline with a Figure 6-2: A Market for Gasoline with a Price CeilingPrice CeilingFigure 6-2: A Market for Gasoline with a Figure 6-2: A Market for Gasoline with a Price CeilingPrice Ceiling
Chapter 6: Page 11
• 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.
• One economist called rent control “the best way to destroy a city, other than bombing.”
• 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.
• One economist called rent control “the best way to destroy a city, other than bombing.”
CASE STUDY:CASE STUDY: Rent Control in the Short Run Rent Control in the Short Run and Long Runand Long RunCASE STUDY:CASE STUDY: Rent Control in the Short Run Rent Control in the Short Run and Long Runand Long Run
Chapter 6: Page 12
Quantity of Apartments
Rental Price of
Apartment
Demand
Supply
(a) Short Run (Supply and Demand are Inelastic)
Controlled rent
0 0
(b) Long Run (Supply and Demand are Elastic)
Shortage
Quantity of Apartments
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Figure 6-3: Rent Control in the Short Run Figure 6-3: Rent Control in the Short Run and Long Runand Long RunFigure 6-3: Rent Control in the Short Run Figure 6-3: Rent Control in the Short Run and Long Runand Long Run
Chapter 6: Page 13
• When the government imposes a price floor, two outcomes are possible.
• The price floor is not binding if set below the equilibrium price.
• The price floor is binding if set above the equilibrium price, leading to a surplus.
• When the government imposes a price floor, two outcomes are possible.
• The price floor is not binding if set below the equilibrium price.
• The price floor is binding if set above the equilibrium price, leading to a surplus.
How Price Floors Affect Market How Price Floors Affect Market OutcomesOutcomes
How Price Floors Affect Market How Price Floors Affect Market OutcomesOutcomes
Chapter 6: Page 14
Quantity of Ice-Cream
Cones
Price of Ice-Cream
Cone
Demand
Supply
Equilibrium price
$3
(a) A Price Floor That is Not Binding (b) A Price Floor That is Binding
$2
Price Floor
Quantity of Ice-Cream
Cones
100Equilibrium
quantity
Price of Ice-Cream
Cone
Demand
Supply
$4Price ceiling
$3
80
QD
Equilibrium price
120
QS
Surplus
0 0
Figure 6-4: A Market with a Price FloorFigure 6-4: A Market with a Price FloorFigure 6-4: A Market with a Price FloorFigure 6-4: A Market with a Price Floor
Chapter 6: Page 15
• A Binding Price Floor creates. . .– Surpluses (i.e. Quantity Supplied >
Quantity Demanded)– Non-Price Rationing - An alternative
mechanism for rationing of the good: Discrimination Criteria
– Examples: Minimum Wage Agricultural Price Supports
• A Binding Price Floor creates. . .– Surpluses (i.e. Quantity Supplied >
Quantity Demanded)– Non-Price Rationing - An alternative
mechanism for rationing of the good: Discrimination Criteria
– Examples: Minimum Wage Agricultural Price Supports
How Price Floors Affect Market How Price Floors Affect Market OutcomesOutcomes
How Price Floors Affect Market How Price Floors Affect Market OutcomesOutcomes
Chapter 6: Page 16
• An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.
• An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.
CASE STUDY:CASE STUDY: The Minimum WageThe Minimum WageCASE STUDY:CASE STUDY: The Minimum WageThe Minimum Wage
Chapter 6: Page 17
Labour demand
Labour supply
Quantity of Labour
Wage
Labour demand
Labour supply
Equilibrium wage
(a) A Free Labour Market (b) A Labour Market with a Binding Minimum Wage
Quantity of Labour
Equilibrium employment
Wage
Minimum wage
Labour surplus
(unemployment)
0 0 Quantity demanded
Quantity supplied
Figure 6-5: How the Minimum Wage Affects Figure 6-5: How the Minimum Wage Affects the Labour Marketthe Labour MarketFigure 6-5: How the Minimum Wage Affects Figure 6-5: How the Minimum Wage Affects the Labour Marketthe Labour Market
Chapter 6: Page 18
• What is the purpose of government- imposed taxes?
– To raise government revenues.– To restrict production of a product.
• What is an excise tax?– A “per-unit” tax that’s independent of
the price of the product.
• What is the purpose of government- imposed taxes?
– To raise government revenues.– To restrict production of a product.
• What is an excise tax?– A “per-unit” tax that’s independent of
the price of the product.
TAXESTAXESTAXESTAXES
Chapter 6: Page 19
• Who pays the tax on a good? The buyer or the seller?
• How is the burden of a tax divided between buyer and seller?
• When the government levies a tax on a good, the equilibrium quantity of the good falls. The size of the market for that good shrinks, shifting either the demand or supply curve.
• Tax incidence: The study of who bears the burden of taxation.
• Who pays the tax on a good? The buyer or the seller?
• How is the burden of a tax divided between buyer and seller?
• When the government levies a tax on a good, the equilibrium quantity of the good falls. The size of the market for that good shrinks, shifting either the demand or supply curve.
• Tax incidence: The study of who bears the burden of taxation.
TAXESTAXESTAXESTAXES
Chapter 6: Page 20
• Taxes discourage market activity.• When a good is taxed, the quantity sold
is smaller. • Buyers and sellers share the tax burden.
• Taxes discourage market activity.• When a good is taxed, the quantity sold
is smaller. • Buyers and sellers share the tax burden.
How Taxes on Buyers (and Sellers) Affect How Taxes on Buyers (and Sellers) Affect Market OutcomesMarket Outcomes
How Taxes on Buyers (and Sellers) Affect How Taxes on Buyers (and Sellers) Affect Market OutcomesMarket Outcomes
Chapter 6: Page 21
D1
S1
0 Quantity of Ice-Cream Cone
Price of Ice-Cream
Cone
$3.00
100
D2
Equilibrium without tax
90
$2.80
$3.30
Equilibrium with tax
Tax ($0.50)
Price buyers pay
Price without tax
Price sellers receive
A tax on buyers shifts the demand curve downward by size of the tax ($0.50).
Figure 6-6: A Tax on BuyersFigure 6-6: A Tax on BuyersFigure 6-6: A Tax on BuyersFigure 6-6: A Tax on Buyers
Chapter 6: Page 22
D1
S1
0 Quantity of Ice-Cream Cone
Price of Ice-Cream
Cone
$3.00
100
Equilibrium without tax
$2.80
Equilibrium with tax
Tax ($0.50)
Price buyers pay
Price without tax
Price sellers receive
A tax on sellers shifts the supply curve upward by an amount of the tax ($0.50).
S2
90
$3.30
Figure 6-7: A Tax on SellersFigure 6-7: A Tax on SellersFigure 6-7: A Tax on SellersFigure 6-7: A Tax on Sellers
Chapter 6: Page 23
• Example: Employment Insurance.• A payroll tax places a wedge between the
wage the workers receive and the wage the firm pays.
• Example: Employment Insurance.• A payroll tax places a wedge between the
wage the workers receive and the wage the firm pays.
CASE STUDY:CASE STUDY: The Burden of a Payroll taxThe Burden of a Payroll taxCASE STUDY:CASE STUDY: The Burden of a Payroll taxThe Burden of a Payroll tax
Chapter 6: Page 24
Quantity of Labour
Wage
Labour
demand
Labour supply
Wage without tax
0
Tax wedge
Wage firms pay
Wage workers receive
Figure 6-8: A Payroll TaxFigure 6-8: A Payroll TaxFigure 6-8: A Payroll TaxFigure 6-8: A Payroll Tax
Chapter 6: Page 25
• Consider a tax levied on sellers of a good. What are the effects of this tax?
• How do effects of the tax levied on the seller compare with those of the effects imposed on the buyer?
• Depends on Elasticity of Demand and Elasticity of Supply.
• Consider a tax levied on sellers of a good. What are the effects of this tax?
• How do effects of the tax levied on the seller compare with those of the effects imposed on the buyer?
• Depends on Elasticity of Demand and Elasticity of Supply.
Elasticity and Tax incidenceElasticity and Tax incidenceElasticity and Tax incidenceElasticity and Tax incidence
Chapter 6: Page 26
• The burden of a tax falls on the side of the market with the smaller price elasticity!
• The more inelastic the demand and the more elastic the supply results in the consumer paying more of the tax.
• The more elastic the demand and the more inelastic the supply results in the supplier paying more of the tax.
• The burden of a tax falls on the side of the market with the smaller price elasticity!
• The more inelastic the demand and the more elastic the supply results in the consumer paying more of the tax.
• The more elastic the demand and the more inelastic the supply results in the supplier paying more of the tax.
Elasticity and Tax incidenceElasticity and Tax incidenceElasticity and Tax incidenceElasticity and Tax incidence
Chapter 6: Page 27
Elastic Supply, Inelastic Demand
Demand
Quantity
Price
Supply
1. When supply is more elastic than demand …
Price buyers pay
Price without tax
Price sellers receive
Tax
3. …than on producers.
2. …the incidence of the tax falls more heavily on consumers…
Figure 6-9 a): How the Burden of a Tax is Figure 6-9 a): How the Burden of a Tax is Divided.Divided.Figure 6-9 a): How the Burden of a Tax is Figure 6-9 a): How the Burden of a Tax is Divided.Divided.
Chapter 6: Page 28
Inelastic Supply, Elastic Demand
Demand
Quantity
Price
Supply
1. When demand is more elastic than supply …
Price buyers pay
Price without tax
Price sellers receive
Tax
3. …than on consumers.
2. …the incidence of the tax falls more heavily on producers…
Figure 6-9 b): How the Burden of a Tax is Figure 6-9 b): How the Burden of a Tax is DividedDividedFigure 6-9 b): How the Burden of a Tax is Figure 6-9 b): How the Burden of a Tax is DividedDivided
Chapter 6: Page 29
• 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.
• 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.
SummarySummarySummarySummary
Chapter 6: Page 30
• 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.
• 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.
SummarySummarySummarySummary
Chapter 6: Page 31
• 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.
• The burden tends to fall on the side of the market that is less elastic.
• 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.
• The burden tends to fall on the side of the market that is less elastic.
SummarySummarySummarySummary
Chapter 6: Page 32
The EndThe EndThe EndThe End