g - St. Johns County School District

N. Gregory Mankiw Principles of Economics Sixth Edition 6 Supply, Demand, and Government Policies 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Premium PowerPoint Slides by Ron 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 do the effects depend on whether the tax is imposed on buyers or sellers? What is the incidence of a tax? What determines the incidence? 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2 Government Policies That Alter the Private Market Outcome Price controls

Price ceiling: a legal maximum on the price of a good or service Example: rent control Price floor: a legal minimum on the price of a good or service Example: minimum wage Taxes The govt can make buyers or sellers pay a specific amount on each unit. 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 eqm quantity). 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 3 EXAMPLE 1: The Market for Apartments P Rental price of apts S $800 Eqm w/o price controls D 300 Q Quantity of apts 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 4

How Price Ceilings Affect Market Outcomes A price ceiling above the eqm price is not binding has no effect on the market outcome. P S Price ceiling $1000 $800 D 300 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Q 5 How Price Ceilings Affect Market Outcomes The eqm price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constraint on the price, causes a shortage.

P S $800 Price ceiling $500 shortage 250 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 400 D Q 6 How Price Ceilings Affect Market Outcomes In the long run, supply and demand are more price-elastic. So, the shortage is larger. P S $800 Price ceiling $500

shortage 150 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 450 D Q 7 Shortages and Rationing With a shortage, sellers must ration the goods among buyers. Some rationing mechanisms: (1) Long lines (2) Discrimination according to sellers biases These mechanisms are often unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly. In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair). 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 8 EXAMPLE 2: The Market for Unskilled Labor Wage paid to unskilled workers W S

$6.00 Eqm w/o price controls D 500 L Quantity of unskilled workers 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 9 How Price Floors Affect Market Outcomes A price floor below the eqm price is not binding has no effect on the market outcome. W S $6.00 Price floor $5.00 D 500 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

L 10 How Price Floors Affect Market Outcomes The eqm wage ($6) W is below the floor $7.25 and therefore illegal. The floor is a binding constraint on the wage, causes a surplus (i.e., unemployment). labor surplus S Price floor $6.00 D 400 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 550 L 11 The Minimum Wage Min wage laws do not affect

highly skilled workers. They do affect teen workers. Studies: A 10% increase in the min wage raises teen unemployment by 13%. W unemployment S Min. wage $7.25 $6.00 D 400 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 550 L 12 ACTIVE LEARNING 1 Price controls P 140

Determine effects of: A. $90 price ceiling The market for hotel rooms 130 S 120 110 100 90 B. $90 price floor 80 C. $120 price floor 60 D 70 50 40 0 Q 50 60 70 80 90 100 110 120 13 130 2012 Cengage 2012 Cengage Learning. Learning.

All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. ACTIVE LEARNING 1 A. $90 price ceiling

The price falls to $90. Buyers demand 120 rooms, sellers supply 90, leaving a shortage. P 140 The market for hotel rooms S 130 120 110 100 90 Price ceiling 80 70 D shortage = 30 60 50 40 0 Q 50 60 70 80 90 100 110 120 14 130 2012

Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. ACTIVE LEARNING

1 B. $90 price floor Eqm price is above the floor, so floor is not binding. P = $100, Q = 100 rooms. P 140 The market for hotel rooms 130 S 120 110 100 90 80 Price floor D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 15 130 2012

Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. ACTIVE LEARNING

1 C. $120 price floor The price rises to $120. Buyers demand 60 rooms, sellers supply 120, causing a surplus. P 140 130 The market for hotel rooms surplus = 60 120 110 S Price floor 100 90 80 D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 16

130 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use.

use. Evaluating Price Controls Recall one of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity. Prices are the signals that guide the allocation of societys resources. This allocation is altered when policymakers restrict prices. Price controls often intended to help the poor, but often hurt more than help. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 17 Taxes 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 % of the goods price, or a specific amount for each unit sold. For simplicity, we analyze per-unit taxes only. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 18 EXAMPLE 3: The Market for Pizza Eqm w/o tax P S1 $10.00 D1 500 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Q 19 A Tax on Buyers The price buyers pay Hence, a tax on buyers is nowthe $1.50 higher than shifts D curve down the market price by the amount ofP. the tax. P P would have to fall by $1.50 to make $10.00 buyers willing to buy same Q as before. $8.50 Effects of a $1.50 per unit tax on buyers E.g., if P falls from $10.00 to $8.50,

buyers still willing to purchase 500 pizzas. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. S1 Tax D1 D2 500 Q 20 A Tax on Buyers Effects of a $1.50 per unit tax on buyers New eqm: Q = 450 Sellers receive PS = $9.50 Buyers pay PB = $11.00 P PB = $11.00 Tax S1 $10.00 PS = $9.50 Difference between them = $1.50 = tax

2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. D1 D2 450 500 Q 21 The Incidence of a Tax: how the burden of a tax is shared among market participants In our example, buyers pay $1.00 more, P PB = $11.00 Tax S1 $10.00 PS = $9.50 sellers get $0.50 less. D1 D2 450 500 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Q

22 A Tax on Sellers The tax effectively raises sellers costs by P $1.50 per pizza. $11.50 Sellers will supply 500 pizzas only if P rises to $11.50, to compensate for this cost increase. Effects of a $1.50 per unit tax on sellers S2 Tax S1 $10.00 Hence, a tax on sellers shifts the S curve up by the amount of the tax. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. D1 500 Q 23 A Tax on Sellers Effects of a $1.50 per unit tax on sellers New eqm: Q = 450 Buyers pay PB = $11.00

Sellers receive PS = $9.50 P PB = $11.00 S2 Tax S1 $10.00 PS = $9.50 Difference between them = $1.50 = tax 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. D1 450 500 Q 24 The Outcome Is the Same in Both Cases! The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers! What matters is this: A tax drives a wedge between the price buyers pay and the price sellers receive.

P PB = $11.00 Tax S1 $10.00 PS = $9.50 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. D1 450 500 Q 25 ACTIVE LEARNING 2 Effects of a tax Suppose govt imposes a tax on buyers of $30 per room. Find new Q, PB, PS, and incidence of tax. P 140 The market for hotel rooms 130

S 120 110 100 90 80 D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 26130 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted

permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. ACTIVE LEARNING 2 Answers P 140 Q = 80 PB = $110 PS = $80 Incidence buyers: $10 sellers: $20 The market for hotel rooms 130 S

120 PB = 110 100 90 Tax PS = 80 D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 27130 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as

permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. Elasticity and Tax Incidence CASE 1: Supply is more elastic than demand Its easier for sellers than buyers to leave the market. So buyers bear most of the burden of the tax. P Buyers share of tax burden PB Tax Price if no tax Sellers share

of tax burden S PS D Q 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 28 Elasticity and Tax Incidence CASE 2: Demand is more elastic than supply P Buyers share of tax burden S PB Price if no tax Sellers share of tax burden Its easier for buyers than sellers to leave the market. Sellers bear most of the burden of the tax. Tax PS D

Q 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 29 CASE STUDY: Who Pays the Luxury Tax? 1990: Congress adopted a luxury tax on yachts, private airplanes, furs, expensive cars, etc. Goal: raise revenue from those who could most easily afford to paywealthy consumers. But who really pays this tax? 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 30 CASE STUDY: Who Pays the Luxury Tax? The market for yachts P Buyers share of tax burden Demand is price-elastic. S PB In the short run, supply is inelastic. Tax Sellers share of tax burden PS

D Q 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Hence, companies that build yachts pay most of the tax. 31 ACTIVE LEARNING 3 The 2011 payroll tax cut Prior to 2011, the Social Security payroll tax was 6.2% taken from workers pay and 6.2% paid by employers (total 12.4%). The Tax Relief Act (2010) reduces the workers portion from 6.2% to 4.2% (for 2011 only), but leaves the employers portion at 6.2%. QUESTION: Will the typical workers take-home pay rise by exactly 2%, more than 2%, or less than 2%? Do any elasticities affect your answer? Explain. 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied,

scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. 32 ACTIVE LEARNING 3 Answers As long as labor supply and labor demand both have price elasticity > 0, the tax cut will be shared by workers and employers, i.e.,

workers take-home pay will rise less than 2%. The answer does NOT depend on whether labor demand is more or less elastic than labor supply. FOLLOW-UP QUESTION: Who gets the bigger share of this tax cut, workers or employers? How do elasticities determine the answer? 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected

on a password-protected website website for classroom for classroom use. use. 33 ACTIVE LEARNING 3 Answers to follow-up question If labor demand is more elastic than labor supply, workers get more of the tax cut than employers. If labor demand is less elastic than labor supply, employers get the larger share of the tax cut. 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as

for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. 34 CONCLUSION: Government Policies and the Allocation of Resources Each of the policies in this chapter affects the allocation of societys resources. Example 1: A tax on pizza reduces eqm Q. With less production of pizza, resources (workers, ovens, cheese) will become available to other industries. Example 2: A binding minimum wage causes a surplus of workers, a waste of resources. So, its important for policymakers to apply such policies very carefully. 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 35

S U M MA RY A price ceiling is a legal maximum on the price of a good. An example is rent control. If the price ceiling is below the eqm price, it is binding and causes a shortage. A price floor is a legal minimum on the price of a good. An example is the minimum wage. If the price floor is above the eqm price, it is binding and causes a surplus. The labor surplus caused by the minimum wage is unemployment. 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated, or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain

productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. 36 S U M MA RY A tax on a good places a wedge between the price buyers pay and the price sellers receive, and causes the eqm quantity to fall, whether the tax is imposed on buyers or sellers. The incidence of a tax is the division of the burden of the tax between buyers and sellers, and does not depend on whether the tax is imposed on buyers or sellers. The incidence of the tax depends on the price elasticities of supply and demand. 2012 Cengage 2012 Cengage Learning. Learning. All Rights AllReserved. Rights Reserved. May notMay be copied, not be copied, scanned,scanned, or duplicated,

or duplicated, in wholeinorwhole in part, or in except part,for except use as for use as permitted permitted in a license in a distributed license distributed with a certain with a certain productproduct or service or service or otherwise or otherwise on a password-protected on a password-protected website website for classroom for classroom use. use. 37

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