Chapter 6 - Supply, Demand, and Government Policies
Chapter 6 - Supply, Demand, and Government Policies
Chapter 6 - Supply, Demand, and Government Policies
0 100 0 75 125
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
In panel (a), the government imposes a price ceiling of $4. Because the price ceiling is above the
equilibrium price of $3, the price ceiling has no effect, and the market can reach the equilibrium of
supply and demand. In this equilibrium, quantity supplied and quantity demanded both equal 100
cones. In panel (b), the government imposes a price ceiling of $2. Because the price ceiling is
below the equilibrium price of $3, the market price equals $2. At this price, 125 cones are
demanded and only 75 are supplied, so there is a shortage of 50 cones.
3
Figure
P Qs
Giá trần không
rang buộc
PC
E
Qd
Qd Qs
4
Figure Giá trần rang
buộc
P Qs
Qd>Qs Cầu > Cung
Thiếu PC
hụt
Qd
Qs Qd
5
Lines at the gas pump
3…the price
P1 P1 ceiling becomes
binding…
4. …resulting
in a shortage
Demand Demand
8
Rent control in the short run
and the long run
• Adverse effects of rent control in the long run
– Supply and demand - more elastic
• Landlords - not building new apartments & failing to
maintain existing ones
• People - find their own apartments & induce more people
to move into a city
• Large shortage of housing
– Rationing mechanisms
• Long waiting lists
• Preference to tenants without children
• Discriminate on the basis of race
• Bribes to building superintendents
9
Figure 3
Rent control in the short run and in the long run
(a) Rent Control in the Short Run (b) Rent Control in the Long Run
(supply and demand are inelastic) (supply and demand are elastic)
Rental Rental
Price of Price of
Apartment Supply Apartment
Supply
Panel (a) shows the short-run effects of rent control: Because the supply and demand for
apartments are relatively inelastic, the price ceiling imposed by a rent-control law causes only a
small shortage of housing. Panel (b) shows the long-run effects of rent control: Because the supply
and demand for apartments are more elastic, rent control causes a large shortage . 10
Rent control in the short run
and the long run
• People respond to incentives
– Free markets
• Landlords try to keep their buildings clean and safe
• Higher prices
– Rent control – shortages & waiting lists
• Landlords lose their incentive to respond to tenants’
concerns
– Tenants get lower rents & lower-quality housing.
• Policymakers – additional regulations
– Difficult and costly to enforce
11
Controls on Prices
• How price floors affect market outcomes
– Price floor
• Legal minimum on the price at which a good can be
sold
• Not binding
– Below the equilibrium price
– No effect
• Binding constraint
– Above the equilibrium price
– Surplus
– Some seller are unable to sell what they want
» The rationing mechanisms – not desirable
12
P Qs
Giá sàn không
rang buộc
PF
Below the equilibrium price
Qd
Qd Qs
13
P Qs
Giá sàn rang buộc
PF
Qd
Qd Qs
14
Figure 4
A market with a price floor
(a) A price floor that is not binding (b) A price floor that is binding
Price of Price of
Ice Ice
Cream Supply Cream Surplus
Supply
Cone Cone
$4
Price floor
$3 3
Equilibrium Equilibrium
price price
Price floor
2
Demand Demand
0 100 0 80 120
Quantity of Ice-Cream Cones Quantity of Ice-Cream Cones
In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium
price of $3, the price floor has no effect. The market price adjusts to balance supply and
demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In
panel (b), the government imposes a price floor of $4, which is above the equilibrium price of
$3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and
only 80 are demanded, there is a surplus of 40 cones.
15
The minimum wage
16
The minimum wage
17
The minimum wage
18
Figure 5
How the minimum wage affects the labor market
(a) A free labor market (b) A Labor Market with a
Binding Minimum Wage
Wage Wage
Labor Labor
supply Labor surplus supply
(unemployment)
Minimum
wage
Equilibrium
wage
Labor Labor
demand demand
Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor
demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is
a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded.
The result is unemployment. 19
Controls on Prices
• Evaluating price controls
• Markets are usually a good way to organize
economic activity
– Economists usually oppose price ceilings and
price floors
• Prices – coordinate economic activity
20
Controls on Prices
• Evaluating price controls
• Governments can sometimes improve market
outcomes
– Price controls - because of unfair market
outcome
– Aimed at helping the poor
– Often hurt those they are trying to help
– Other ways of helping those in need
• Rent subsidies
• Wage subsidies
21
Practice:
Assume that the demand and supply functions for Computer in country A
are as follows:
QD = - 360P+600, QS= 1080P – 120
(The unit of price is USD, the unit of quantity is million Computers)
1. Determine the equilibrium point (quantity and price). What is the sum
of producer revenue and consumer spending?
2. Assuming the government sets a floor price of 0.6 USD/Computer,
determine the excess. If the government wants to buy back the surplus,
how much money should it spend?
22
QD = - 360P+600,
QS= 1080P – 120
Qd=Qs = - 360P+600=1080P-120
1440P=720 =>P= 0,5 USD
Q=1080*0,5-120= 420 (C)
Q=420 C
TR=P*Q= 0,5*420+210
PFloor=0,6 USD
QS= 1080Pfloor – 120=1080*0,6-120=528, Qs=528
Qd=- 360P+600= -360*0,6+600= 384,Qd=384
Lương dư thừa: Q= Qs-Qd=528-384= 144(Computer)
Price floor=0,6=> 144C
G= 144*0,6= 86,4 Triệu USD
23
• Q1:The market is in equilibrium when the quantity supplied equals the
quantity demanded, or QS = QDo 1080P – 120= - 360P + 600o
1440P = 720o P = 0.5, substitute PT for the supply or demand curveQ =
420 So the market is in equilibrium at price P=0.5 (USD/Computer)
and output Q=420 (million Computers).Producer revenue equals
consumer spending= P*Q = 0.5*420 = $210 million
• Q2:When the government sets a floor price of 0.6, which is higher
than the fair price, supply and demand will not be in balance. At this
priceThe quantity supplied isQs = 1080*0.6 – 120 = 528 (potential
P=0.6 on supply curve PT)Quantity demanded isQD = - 360*0.6 + 600
=384 (potential P=0.6 on demand curve PT)Excess amount: Q = QS –
QD = 528 – 384 = 144So at the specified floor price, the market has a
surplus of 144 million Computers.If the government buys up the
excess, Amount to spend = 144 * 0.6 = 86.4 million USD
24
Taxes
• Tax incidence
– Manner in which the burden of a tax is shared
among participants in a market
• How taxes on sellers affect market outcomes
– Immediate impact on sellers
• Shift in supply
– Supply curve shifts left
– Higher equilibrium price
– Lower equilibrium quantity
– The tax – reduces the size of the market
25
Figure 6
A tax on sellers
Price of A tax on sellers
Ice-Cream shifts the supply
Cone Equilibrium with tax
S2 curve upward
Price S1 by the size of
buyers the tax ($0.50).
pay
$3.30
Price Tax
without 3.00 ($0.50) Equilibrium without tax
tax 2.80
Price
sellers
receive
Demand, D1
0 90 100 Quantity of
Ice-Cream Cones
When a tax of $0.50 is levied on sellers, the supply curve shifts up by $0.50 from S 1 to S2. The
equilibrium quantity falls from 100 to 90 cones. The price that buyers pay rises from $3.00 to
$3.30. The price that sellers receive (after paying the tax) falls from $3.00 to $2.80. Even though
the tax is levied on sellers, buyers and sellers share the burden of the tax.
26
Taxes
• How taxes on sellers affect market outcomes
– Taxes discourage market activity
– Smaller quantity sold
– Buyers and sellers share the burden of tax
– Buyers pay more
• Worse off
– Sellers receive less
• Get the higher price but pay the tax
• Overall: effective price fall
• Worse off
27
Taxes
• How taxes on buyers affect market outcomes
– Initial impact on the demand
– Demand curve shifts left
– Lower equilibrium price
– Lower equilibrium quantity
– The tax – reduces the size of the market
28
Figure 7
A tax on buyers
Price of
Ice-Cream
Equilibrium with tax
Cone
Price Supply, S1
buyers
pay Equilibrium without tax
$3.30
Price Tax A tax on buyers
without 3.00 ($0.50) shifts the demand
tax curve downward
2.80
by the size of
Price the tax ($0.50).
sellers
receive
D1
D2
0 90 100 Quantity of
Ice-Cream Cones
When a tax of $0.50 is levied on buyers, the demand curve shifts down by $0.50 from D 1 to D2.
The equilibrium quantity falls from 100 to 90 cones. The price that sellers receive falls from $3.00
to $2.80. The price that buyers pay (including the tax) rises from $3.00 to $3.30. Even though the
tax is levied on buyers, buyers and sellers share the burden of the tax. 29
Taxes
• How taxes on buyers affect market outcomes
– Buyers and sellers share the burden of the tax
– Sellers get a lower price
• Worse off
– Buyers pay a lower market price
• Effective price (with tax) rises
• Worse off
• Taxes levied on sellers and taxes levied on
buyers are equivalent
30
Can congress distribute the burden of
a payroll tax?
• Payroll taxes
– Deducted from the amount you earned
• By law, the tax burden:
– Half of the tax - paid by firms
• Out of firm’s revenue
– Half of the tax - paid by workers
• Deducted from workers’ paychecks
• Tax incidence analysis
– Payroll tax = tax on a good
• Good = labor
• Price = wage
31
Can congress distribute the burden of
a payroll tax?
• Introduce payroll tax
– Wage received by workers falls
– Wage paid by firms rises
– Workers and firms share the burden of the tax
• Not necessarily fifty-fifty as the legislation requires
• Lawmakers
– Can decide whether a tax comes from the buyer’s
pocket or from the seller’s
– Cannot legislate the true burden of a tax
• Tax incidence: forces of supply and demand
32
Figure 8
A payroll tax
Wage
Labor
supply
Wage workers
receive
Labor
demand
0 Quantity of
Labor
A payroll tax places a wedge between the wage that workers receive and the wage that firms
pay. Comparing wages with and without the tax, you can see that workers and firms share the tax
burden. This division of the tax burden between workers and firms does not depend on whether
the government levies the tax on workers, levies the tax on firms, or divides the tax equally
between the two groups.
33
Taxes
• Elasticity and tax incidence
• Dividing the tax burden
– Very elastic supply and relatively inelastic
demand
• Sellers – small burden of tax
• Buyers – most of the burden
– Relatively inelastic supply and very elastic
demand
• Sellers – most of the tax burden
• Buyers – small burden
34
Figure 9
How the burden of a tax is divided (a)
(a) Elastic Supply, Inelastic Demand
Price
1. When supply is more
elastic than
demand . . .
Supply
Price buyers pay
Price sellers
receive 3. . . . Than on
producers.
Demand
0 Quantity
In panel (a), the supply curve is elastic, and the demand curve is inelastic. In this case, the price
received by sellers falls only slightly, while the price paid by buyers rises substantially. Thus,
buyers bear most of the burden of the tax. 35
Figure 9
How the burden of a tax is divided (b)
(b) Inelastic Supply, Elastic Demand
Price
1. When demand is
more elastic than
supply . . .
Supply
Price buyers pay
3. Than on consumers
Price without tax Tax
Demand
2. . . . The incidence of
Price sellers the tax falls more heavily
receive on producers.
0 Quantity
In panel (b), the supply curve is inelastic, and the demand curve is elastic. In this case, the price
received by sellers falls substantially, while the price paid by buyers rises only slightly. Thus,
sellers bear most of the burden of the tax. 36
Taxes
• Tax burden - falls more heavily on the side of
the market that is less elastic
– Small elasticity of demand
• Buyers do not have good alternatives to
consuming this good
– Small elasticity of supply
• Sellers do not have good alternatives to
producing this good
37
Who pays the luxury tax?
38