Supply, Demand and Government Policies. Supply, Demand, and Government Policies. Price Ceilings & Price Floors. Chapter 6.

Transcription

1 , and Government Policies Chapter 6 Copyright 21 by Harcourt, Inc. All rights reserved. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department, Harcourt College Publishers, 6277 Sea Harbor Drive, Orlando, Florida ,, and Government Policies u In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. u One of the things government can do is to set price controls when the market price is seen as unfair to either buyers or sellers. Ceilings & Floors Ceiling u A legally established maximum price at which a good can be sold. (Rent Controls) Floor u A legally established minimum price at which a good can be sold. ( Supports for Agriculture) 1

2 Ceilings Two outcomes are possible when the government imposes a price ceiling: u The price ceiling is not binding if set above the equilibrium price. u The price ceiling is binding if set below the equilibrium price, leading to a shortage. u Binding means that there is an economic impact. A Ceiling That Is Binding... of price $ supplied Shortage 125 demanded ceiling s A Ceiling That Is Not Binding... of $4 3 ceiling price 1 quantity s 2

3 Effects of Ceilings A binding price ceiling creates... º shortages because Q D > Q S. u Example: Gasoline shortage of the 197s º nonprice rationing u Examples: Long lines, Discrimination by sellers The Ceiling on Gasoline Is Not Binding... of Gasoline 1. Initially, the price ceiling is not binding... $4 ceiling P 1 Q 1 Gasoline The Ceiling on Gasoline Is Binding... of Gasoline S 2 2. but when supply falls... S 1 P 2 ceiling 4. resulting in a shortage. P 1 3. the price ceiling becomes binding... Q 1 Gasoline 3

4 Rent Control u Rent controls are ceilings placed on the rents that landlords may charge their tenants. u Rent control can make housing more affordable. u With a price ceiling, you cannot go above the ceiling. u But what about the landlords? Rent Control in the Short Run... Rental of Apartment and demand for apartments are relatively inelastic-why is the supply curve vertical? Controlled rent Shortage Apartments Rent Control in the Long Run... Rental of Apartment Because the supply and demand for apartments are more elastic... What happens in the long run? rent control causes a large shortage Shortage Controlled rent Apartments 4

5 Floors When the government imposes a price floor, two outcomes are possible. u The price floor is not binding if set below the equilibrium price. u The price floor is binding if set above the equilibrium price, leading to a surplus. u Think of price floors as not being able to go below the floor. A Floor That Is Not Binding... of price $3 2 floor 1 quantity s A Floor That Is Binding... of $4 $3 Surplus floor price 8 demanded 12 supplied s 5

6 Effects of a Floor A binding price floor causes... º a surplus because Q S >Q D. º nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. uexamples: The minimum wage, Agricultural price supports ustate Minimum Wages The Minimum Wage Wage A Free Market supply wage employment demand The Minimum Wage Wage Minimum wage A Market with a Minimum Wage surplus (unemployment) supply demanded supplied demand 6

7 What are some potential impacts of taxes? u Taxes are used to raise money for the government. u Taxes discourage market activity. u When a good is taxed, the quantity sold is smaller. u Buyers and sellers share the tax burden. u But who bears the burden-tax incidence. Impact of a 5 Tax Levied on Buyers... of buyers pay without tax $ Tax ($.5) Copyright 21 by Harcourt, Inc. All rights reserved, S 1 without tax sellers receive with tax D 1 D s Copyright 21 by Harcourt, Inc. All rights reserved Impact of a 5 Tax on Sellers... buyers pay without tax of sellers receive $ with tax Tax ($.5) S 2 S 1 A tax on sellers shifts the supply curve upward by the amount of the tax ($.5). without tax, D s 7

8 The Incidence of Tax uin what proportions is the burden of the tax divided? uhow do the effects of taxes on sellers compare to those levied on buyers? The answers to these questions depend on the elasticity of demand and the elasticity of supply. Elastic, Inelastic... buyers pay without tax sellers receive Tax 1. When supply is more elastic than demand the incidence of the tax falls more heavily on consumers than on producers. Inelastic, Elastic... buyers pay without tax Tax 1. When demand is more elastic than supply than on consumers. sellers receive 2....the incidence of the tax falls more heavily on producers... 8