Chapter 6 Supply Demand And Government Policies Effects of gov't ...
Chapter 6 Supply Demand And Government Policies Effects of gov't policies that place ceiling on prices Examine effects of gov't policies that put 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 split between buyers and sellers. Economists have two jobs : Scientists and Policy Makers. Controls on Prices If gov't enforces legal maximum on the price at which ice cream can be sold: not allowed to rise above this level: Price Ceiling. Price Ceiling: A legal maximum on the price at which a good can be sold Gov't imposes legal minimum on price: price cannot fall below the level: Price Floor. Price Floor: A legal minimum on a price at which a good can be sold.
How Price Ceilings Affect Market Outcomes Figure 6.1 Gov't imposes price ceiling of $4 per cone. Price that balances supply and demand ($3) is below the ceiling, the price ceiling is not binding. Market forces naturally move economy to the equilibrium. Price ceiling has NO EFFECT on supply and quantity sold. Graph 1
Equilibrium price of $3 is above price ceiling: binding constraint on market. Forces of supply demand can reach equilibrium, but can rise no further once hit ceiling price. Thus, MARKET PRICE=PRICE CEILING. (Qd exceeds Qs in graph). Mechanisms drop when shortage of ice cream develops due to price ceiling. Mechanisms: long lines Not all buyers benefit from policy. Buyers have lower price but wait longer lines
inefficient, wastes buyer's time Thus, Rationing mechanisms that develop under price ceiling are rarely desirable Rationing mechanisms in a free competitive market is both efficient and impersonal. When market for ice cream reaches equilibrium: everyone can get a cone. Free market ration goods with prices. When the gov't imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers. Case Study Lines at Gas Pump OPEC raised prices of crude oil in world oil markets. Major input to make gasoline. higher oil prices reduced supply of gas. Canada: Price rose, very few shortages. US: long lines: Blame OPEC for raise of gas prices shortage of gas would not have occured. Economists blamed U.S gov't regulations that limited the price that oil companies could change for gas. Graph 6.2
Case Study
RENT CONTROL IN THE SHORT RUN AND LONG RUN Example of price ceiling is rent control. Provincial gov't places a ceiling on rents that landlords may charge their tenants. Goal: to help poor by making housing more afforadable. Arguments: Highly inefficient way to help poor raise standard of living. Short Run: Landlords have a fixed number of apartments to rent, cannot adjust quickly as market conditions change. People take time adjusting their housing arrangements: number of people are not highly responsive to rents in short run. 6.3 graph.
Short Run effects: Any binding price ceiling, rent control causes shortages. Supply and demand are inelastic in short run, the initial shortage caused by rent control is small. Long run buyers and sellers of rental housing respond more to market conditions as time passes Supply side: Landlords respond low to rents by not building new apartments and maintaining existing ones. Demand side: Low rents= people find their own apartments (rather than sharing house or being with parents) and induce people to move in cities. Both Supply and Demand are thus more elastic in the long run.
6.3
How Price Floors Affect Market Outcomes Gov't Price controls:
Price Flooring: places legal Minimum Price Ceiling: Legal Maximum Both attempts by gov't to maintain prices at other than equilibrium prices. Price Flooring: for example when gov't is persuaded by the pleas of the Canadian Org. of Ice cream makers.
2 outcomes are possible: $2 per cone when equilibrium is $3, outcome: a) Equilibrium above price floor: Price floor is NOT BINDING. $4 price floor : above equilibrium price $3. Eq price is below price floor = Price floor is a BINDING CONSTRAINT ON MARKET. Forces of Supply and Demand move to the price toward equilibrium price. When market hits floor price, it can fall no further. MARKET PRICE= PRICE FLOOR
At Price floor: Market Price: $4. 120 cones supplied 80 demanded: Surplus of 40. Binding price floor causes SURPLUS.
Price ceilings and shortages can lead to undesirable rationing mechanisms as well as Price Floors and Surpluses. The seller who appeal to the personal biases of the buyers (racial familial ties) are better able to sell their goods. Free market equilibrium serves as the rationing mechanism, and sellers can sell all they want at the equilibrium.
Case Study Minimum Wage example of price floor. Minimum wage: laws dictate lowest price for labour that any employer may pay. Minimum wage rates differ in each province and territory
Unemployment: minimum wage is above equilibrium level: Quantity of labour exceeds quantity demanded. = Min wage raises the incomes of those employed but lowers incomes of those who cannot find jobs. Economy contains not a single market, but many labour markets for different types of workers. Experienced skilled workers not affected because equilibrium wages are above minimum. Minimum wage is NOT BINDING. Teenage Labour interns and training Interns pay nothing so equilibrium does not affect them either (hence existence) Minimum wage is more binding to teens than other members of labour force. Increase in Wage: affects job hunting. Attend schools drop out and take job. New dropouts displace already dropped out teens now unemployed. Pros: workers earning MW are poor poor better off with increase wage Cons: Not the best way to combat poverty. causes unemployment drop out prevents unskilled workers getting on trained job they need poorly targeted policy (not all head of house trying to make $ and feed family) MANY ARE TEENS FOR EXTRA SPENDING CASH. Evaluating Price Controls Markets are usually a good way to organize economic activity (principles) explain economists opposing price ceiling and flooring Prices: supply and demand: balance it. Policymakers set prices by legal decree by allocation's of society's resources. Gov't can sometimes improve market outcomes Policy makers control prices because they view market's outcome as unfair. Price controls aimed to help poor Often hurt poor Rent control may keep rents low but it discourages landlords form maintaining their buildings and makes housing hard to find. Min wage laws may increase incomes of some workers, cause others to be unemployed. Alternatives for helping poor instead of price controls:
Govt can make housing affordable by paying a fraction of the rent. This rent subsidies do no reduce quantity of housing supplied and thus do not lead to housing shortages. Wage subsidies raise living standards of the working poor without discouraging firms from hiring them Rent and wage subsidies can cost govt money and require higher taxes. :/
Quiz: Price ceiling/ floor? Which leads to surplus? shortage? why? Taxes local govt decides to hold annual ice cream celebration. To raise revenue they to place tax on sale of ice cream cones. Both lobbying organizations quarrel. (sellers don't want tax consumers don't want tax). Town mayor: tax paid by the buyers and half the tax be paid sellers. Who bears the burden on the tax? Tax incidence: The manner in which the burden of a tax is shared among participants in a market. How taxes on Buyers affect Market Outcome Does law affect supply or demand curve. Which way does curve shift? How shift effects equilibrium Step one: Affects Demand for ice cream. Supply curve is not affected bc for any given price of ice cream, sellers have to pay a tax to govt and price to sellers. Thus Tax shifts the demand curve for ice cream. Step two: Direction of shift Shifts to left because buyers demand smaller quantity. Tax on buyers shifts the demand curve downward by the size of the tax ($0.50). If market price of cone is 2.00, the effective price to buyers is 2.50. To induce buyers buyers to demand any given quantity, the market price must now 0.50 lower to make up for the effect of the tax. Step three: The effect of tax by comparing the initial equilibrium and the new equilibrium. Equilibrium price falls from 3.00 to 2.80, equilibrium quantity falls from 100 to 90. Buyers buy less, sellers sell less: TAX ON ICE CREAM REDUCES THE SIZE OF ICE CREAM MARKET. Implications: Tax discourage market activity. When a good is taxed, the Quantity of good being sold is smaller in the new equilibrium than the initial equilibrium. Buyers and sellers share burden of the tax. New equilibrium, buyers par more for the good, sellers receive less.
Tax on Buyers: When a tax of 0.50 is levied on buyers, the demand curve shifts down by 0.50. The equilibrium quantity falls from 100 to 90 cones. The price that sellers receive falls from 3.00 to 2.80. Buyers pay 3.00 rising to 3.30. The tax effects buyers and sellers. How tax on Sellers affect Market Outcome govt imposes law requirement for cone they sell. Step one: Tax is not levied on buyers, the quantity of ice cream demanded at any given price is the same. Tax shifts demand curve for ice cream. Step Two: Tax on seller raises the cost of producing and selling ice cream, reduces the quantity supplied at every price. The supply curve shifts to the left (or upward). Magnitude of the shift: If the market price of a cone happened to be $2.00, the effective price received by sellers would be $1.50. Whatever the market price, sellers will supply a quantity of ice cream as if the price were $0.50 lower than it is. To induce sellers to supply any given quantity, the market price must now be $0.50 higher to compensate for the effect of the tax. The supply curve shifts upward. Step Three: Equilibrium price of ice cream rises from 3.00 to 3.30, and the equilibrium quantity falls from 100 to 90 cones. Tax reduces size of ice cream market. Buyers and sellers share the burden of the tax. Market price rises, buyers pay $0.30 more for each cone than they did before the tax was enacted. Sellers receive a higher price than they did without the tax, but the effective price (after paying the tax) falls from 3.00 to 2.80. Implications Buyers and Sellers share the burden of taxes. Case Study CAN PARLIAMENT DISTRIBUTE THE BURDEN OF A PAYROLL TAX? Paycheck: taxes are deducted from the amount you earned. One taxes is called: Employment Insurance. Federal gov't uses revenue from EI tax to pay for benefits to unemployed workers and training programs and policies. EI: Tax on wages that firms pay their workers.
58% of tax is paid by firms and 42% by paid by workers' paycheques. when a payroll tax is enacted, the wage received by workers falls, and wage paid by firms rises. Worker and Firms share the burden of tax (has nothing to do with tax division). Lawmakers can decide whether a tax comes from the buyer's pocket or form seller's, but they cannot legislate the true burden of a tax. Tax depends on the forces of supply and demand. Diagram 6.8 A payroll tax places a wedge between the wage that workers receive and the wage tha firms pay. Comparing wages with and without the tax you can see that workers and firms share the tax burden. The division of the tax burden between workers and firms does not depend on whether the gov't levies the tax on workers, levies the tax on firms, or divides tax equally between the two groups.
Elasticity and Tax Incidence When a good is taxed, buyers and sellers of the good share the burden of the tax. Figure 6.9 1. ELASTIC SUPPLY, INELASTIC DEMAND: price received by seller falls only slightly, price paid by buyers rises substantially: BUYERS BEAR MOST OF THE BURDEN OF THE TAX. (SUPPLY CURVE IS FLAT, DEMAND: STEEP). 2. INELASTIC SUPPLY, ELASTIC DEMAND: Supply curve is inelastic and demand curve is elastic. Price received by sellers falls substantially, while the price paid by buyer rises only slightly: SELLERS BEAR MOST OF THE BURDEN OF THE TAX. A tax burden falls more heavily on the side of the market that is less elastic. Elasticity: measures the willingness of buyers or sellers to leave the market when conditions become unfavorable. Small elasticity of demand: Buyers do not have good alternatives to consume the particular good. Small elasticity of supply: sellers do not have good alternatives to produce particular good. When good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must bear more of the burden of the tax.
Apply this logic to payroll tax: Most labour economists believe that the supply of labour is much less elastic than the demand. This means that workers bear most of the burden of the payroll tax: DISTRIBUTION OF THE TAX BURDEN IS NOT AT ALL CLOSE TO 5842 SPLIT THAT LAWMAKERS INTENDED. Conclusion: Economy is governed by two kinds of laws: Supply and Demand and the laws of enacted by the gov't. Price controls and taxes: common in various markets. Summary •
Price ceiling is a legal max on price of a good or service. ex: rent control.
If price ceiling is below eq price, Qd exceeds Qs= shortage=sellers must ration the good or service among buyers.
•
Price floor: legal min on price of good or service ex: minimum wage If price floor is above the equilibrium price, the Qs exceeds the quantity demanded. = Surplus= buyer's demands for the goods/s must in some way be rationed among sellers.
•
When gov't levies a tax on a good, the equilibrium quantity of the good FALLS. TAX ON A MARKET SHRINKS THE SIZE OF MARLET
•
A tax on goods places a wedge between the price paid by buyers and the price received by sellers. Market moves to new equilibrium: buyers pay more for the good, Sellers receive less for it.= Buyers and sellers share tax burden Division on tax burden does not depend on whether the tax is levied on buyers or sellers.
•
The incidence of a tax depends on PRICE ELASTICITIES IF SUPPLY AND DEMAND. Burden: falls on LESS ELASTIC side of market: that market can respond less easily to the tax by changing the Quantity bought or sold.
minimize appendices board of directors: what they are how many people
understand what subsidiaries is.
3. b) compensation committee, order committee: companies that coordinate within or across units.: reports: analyst reports, profiles are published: public companies.
How Price Ceilings Affect Market Outcomes Figure 6.1 Gov't imposes price ceiling of $4 per cone. Price that balances supply and demand ($3) is below the ceiling, the price ceiling is not binding. Market forces naturally move economy to the equilibrium. Price ceiling has NO EFFECT on supply and quantity sold. Graph 1
Equilibrium price of $3 is above price ceiling: binding constraint on market. Forces of supply demand can reach equilibrium, but can rise no further once hit ceiling price. Thus, MARKET PRICE=PRICE CEILING. (Qd exceeds Qs in graph). Mechanisms drop when shortage of ice cream develops due to price ceiling. Mechanisms: long lines Not all buyers benefit from policy. Buyers have lower price but wait longer lines
inefficient, wastes buyer's time Thus, Rationing mechanisms that develop under price ceiling are rarely desirable Rationing mechanisms in a free competitive market is both efficient and impersonal. When market for ice cream reaches equilibrium: everyone can get a cone. Free market ration goods with prices. When the gov't imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers. Case Study Lines at Gas Pump OPEC raised prices of crude oil in world oil markets. Major input to make gasoline. higher oil prices reduced supply of gas. Canada: Price rose, very few shortages. US: long lines: Blame OPEC for raise of gas prices shortage of gas would not have occured. Economists blamed U.S gov't regulations that limited the price that oil companies could change for gas. Graph 6.2
Case Study
RENT CONTROL IN THE SHORT RUN AND LONG RUN Example of price ceiling is rent control. Provincial gov't places a ceiling on rents that landlords may charge their tenants. Goal: to help poor by making housing more afforadable. Arguments: Highly inefficient way to help poor raise standard of living. Short Run: Landlords have a fixed number of apartments to rent, cannot adjust quickly as market conditions change. People take time adjusting their housing arrangements: number of people are not highly responsive to rents in short run. 6.3 graph.
Short Run effects: Any binding price ceiling, rent control causes shortages. Supply and demand are inelastic in short run, the initial shortage caused by rent control is small. Long run buyers and sellers of rental housing respond more to market conditions as time passes Supply side: Landlords respond low to rents by not building new apartments and maintaining existing ones. Demand side: Low rents= people find their own apartments (rather than sharing house or being with parents) and induce people to move in cities. Both Supply and Demand are thus more elastic in the long run.
6.3
How Price Floors Affect Market Outcomes Gov't Price controls:
Price Flooring: places legal Minimum Price Ceiling: Legal Maximum Both attempts by gov't to maintain prices at other than equilibrium prices. Price Flooring: for example when gov't is persuaded by the pleas of the Canadian Org. of Ice cream makers.
2 outcomes are possible: $2 per cone when equilibrium is $3, outcome: a) Equilibrium above price floor: Price floor is NOT BINDING. $4 price floor : above equilibrium price $3. Eq price is below price floor = Price floor is a BINDING CONSTRAINT ON MARKET. Forces of Supply and Demand move to the price toward equilibrium price. When market hits floor price, it can fall no further. MARKET PRICE= PRICE FLOOR
At Price floor: Market Price: $4. 120 cones supplied 80 demanded: Surplus of 40. Binding price floor causes SURPLUS.
Price ceilings and shortages can lead to undesirable rationing mechanisms as well as Price Floors and Surpluses. The seller who appeal to the personal biases of the buyers (racial familial ties) are better able to sell their goods. Free market equilibrium serves as the rationing mechanism, and sellers can sell all they want at the equilibrium.
Case Study Minimum Wage example of price floor. Minimum wage: laws dictate lowest price for labour that any employer may pay. Minimum wage rates differ in each province and territory
Unemployment: minimum wage is above equilibrium level: Quantity of labour exceeds quantity demanded. = Min wage raises the incomes of those employed but lowers incomes of those who cannot find jobs. Economy contains not a single market, but many labour markets for different types of workers. Experienced skilled workers not affected because equilibrium wages are above minimum. Minimum wage is NOT BINDING. Teenage Labour interns and training Interns pay nothing so equilibrium does not affect them either (hence existence) Minimum wage is more binding to teens than other members of labour force. Increase in Wage: affects job hunting. Attend schools drop out and take job. New dropouts displace already dropped out teens now unemployed. Pros: workers earning MW are poor poor better off with increase wage Cons: Not the best way to combat poverty. causes unemployment drop out prevents unskilled workers getting on trained job they need poorly targeted policy (not all head of house trying to make $ and feed family) MANY ARE TEENS FOR EXTRA SPENDING CASH. Evaluating Price Controls Markets are usually a good way to organize economic activity (principles) explain economists opposing price ceiling and flooring Prices: supply and demand: balance it. Policymakers set prices by legal decree by allocation's of society's resources. Gov't can sometimes improve market outcomes Policy makers control prices because they view market's outcome as unfair. Price controls aimed to help poor Often hurt poor Rent control may keep rents low but it discourages landlords form maintaining their buildings and makes housing hard to find. Min wage laws may increase incomes of some workers, cause others to be unemployed. Alternatives for helping poor instead of price controls:
Govt can make housing affordable by paying a fraction of the rent. This rent subsidies do no reduce quantity of housing supplied and thus do not lead to housing shortages. Wage subsidies raise living standards of the working poor without discouraging firms from hiring them Rent and wage subsidies can cost govt money and require higher taxes. :/
Quiz: Price ceiling/ floor? Which leads to surplus? shortage? why? Taxes local govt decides to hold annual ice cream celebration. To raise revenue they to place tax on sale of ice cream cones. Both lobbying organizations quarrel. (sellers don't want tax consumers don't want tax). Town mayor: tax paid by the buyers and half the tax be paid sellers. Who bears the burden on the tax? Tax incidence: The manner in which the burden of a tax is shared among participants in a market. How taxes on Buyers affect Market Outcome Does law affect supply or demand curve. Which way does curve shift? How shift effects equilibrium Step one: Affects Demand for ice cream. Supply curve is not affected bc for any given price of ice cream, sellers have to pay a tax to govt and price to sellers. Thus Tax shifts the demand curve for ice cream. Step two: Direction of shift Shifts to left because buyers demand smaller quantity. Tax on buyers shifts the demand curve downward by the size of the tax ($0.50). If market price of cone is 2.00, the effective price to buyers is 2.50. To induce buyers buyers to demand any given quantity, the market price must now 0.50 lower to make up for the effect of the tax. Step three: The effect of tax by comparing the initial equilibrium and the new equilibrium. Equilibrium price falls from 3.00 to 2.80, equilibrium quantity falls from 100 to 90. Buyers buy less, sellers sell less: TAX ON ICE CREAM REDUCES THE SIZE OF ICE CREAM MARKET. Implications: Tax discourage market activity. When a good is taxed, the Quantity of good being sold is smaller in the new equilibrium than the initial equilibrium. Buyers and sellers share burden of the tax. New equilibrium, buyers par more for the good, sellers receive less.
Tax on Buyers: When a tax of 0.50 is levied on buyers, the demand curve shifts down by 0.50. The equilibrium quantity falls from 100 to 90 cones. The price that sellers receive falls from 3.00 to 2.80. Buyers pay 3.00 rising to 3.30. The tax effects buyers and sellers. How tax on Sellers affect Market Outcome govt imposes law requirement for cone they sell. Step one: Tax is not levied on buyers, the quantity of ice cream demanded at any given price is the same. Tax shifts demand curve for ice cream. Step Two: Tax on seller raises the cost of producing and selling ice cream, reduces the quantity supplied at every price. The supply curve shifts to the left (or upward). Magnitude of the shift: If the market price of a cone happened to be $2.00, the effective price received by sellers would be $1.50. Whatever the market price, sellers will supply a quantity of ice cream as if the price were $0.50 lower than it is. To induce sellers to supply any given quantity, the market price must now be $0.50 higher to compensate for the effect of the tax. The supply curve shifts upward. Step Three: Equilibrium price of ice cream rises from 3.00 to 3.30, and the equilibrium quantity falls from 100 to 90 cones. Tax reduces size of ice cream market. Buyers and sellers share the burden of the tax. Market price rises, buyers pay $0.30 more for each cone than they did before the tax was enacted. Sellers receive a higher price than they did without the tax, but the effective price (after paying the tax) falls from 3.00 to 2.80. Implications Buyers and Sellers share the burden of taxes. Case Study CAN PARLIAMENT DISTRIBUTE THE BURDEN OF A PAYROLL TAX? Paycheck: taxes are deducted from the amount you earned. One taxes is called: Employment Insurance. Federal gov't uses revenue from EI tax to pay for benefits to unemployed workers and training programs and policies. EI: Tax on wages that firms pay their workers.
58% of tax is paid by firms and 42% by paid by workers' paycheques. when a payroll tax is enacted, the wage received by workers falls, and wage paid by firms rises. Worker and Firms share the burden of tax (has nothing to do with tax division). Lawmakers can decide whether a tax comes from the buyer's pocket or form seller's, but they cannot legislate the true burden of a tax. Tax depends on the forces of supply and demand. Diagram 6.8 A payroll tax places a wedge between the wage that workers receive and the wage tha firms pay. Comparing wages with and without the tax you can see that workers and firms share the tax burden. The division of the tax burden between workers and firms does not depend on whether the gov't levies the tax on workers, levies the tax on firms, or divides tax equally between the two groups.
Elasticity and Tax Incidence When a good is taxed, buyers and sellers of the good share the burden of the tax. Figure 6.9 1. ELASTIC SUPPLY, INELASTIC DEMAND: price received by seller falls only slightly, price paid by buyers rises substantially: BUYERS BEAR MOST OF THE BURDEN OF THE TAX. (SUPPLY CURVE IS FLAT, DEMAND: STEEP). 2. INELASTIC SUPPLY, ELASTIC DEMAND: Supply curve is inelastic and demand curve is elastic. Price received by sellers falls substantially, while the price paid by buyer rises only slightly: SELLERS BEAR MOST OF THE BURDEN OF THE TAX. A tax burden falls more heavily on the side of the market that is less elastic. Elasticity: measures the willingness of buyers or sellers to leave the market when conditions become unfavorable. Small elasticity of demand: Buyers do not have good alternatives to consume the particular good. Small elasticity of supply: sellers do not have good alternatives to produce particular good. When good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must bear more of the burden of the tax.
Apply this logic to payroll tax: Most labour economists believe that the supply of labour is much less elastic than the demand. This means that workers bear most of the burden of the payroll tax: DISTRIBUTION OF THE TAX BURDEN IS NOT AT ALL CLOSE TO 5842 SPLIT THAT LAWMAKERS INTENDED. Conclusion: Economy is governed by two kinds of laws: Supply and Demand and the laws of enacted by the gov't. Price controls and taxes: common in various markets. Summary •
Price ceiling is a legal max on price of a good or service. ex: rent control.
If price ceiling is below eq price, Qd exceeds Qs= shortage=sellers must ration the good or service among buyers.
•
Price floor: legal min on price of good or service ex: minimum wage If price floor is above the equilibrium price, the Qs exceeds the quantity demanded. = Surplus= buyer's demands for the goods/s must in some way be rationed among sellers.
•
When gov't levies a tax on a good, the equilibrium quantity of the good FALLS. TAX ON A MARKET SHRINKS THE SIZE OF MARLET
•
A tax on goods places a wedge between the price paid by buyers and the price received by sellers. Market moves to new equilibrium: buyers pay more for the good, Sellers receive less for it.= Buyers and sellers share tax burden Division on tax burden does not depend on whether the tax is levied on buyers or sellers.
•
The incidence of a tax depends on PRICE ELASTICITIES IF SUPPLY AND DEMAND. Burden: falls on LESS ELASTIC side of market: that market can respond less easily to the tax by changing the Quantity bought or sold.
minimize appendices board of directors: what they are how many people
understand what subsidiaries is.
3. b) compensation committee, order committee: companies that coordinate within or across units.: reports: analyst reports, profiles are published: public companies.
