Applications of Supply and Demand Chapter 4

Price Controls Floor Ceilings Who benefits from each: sellers or buyers?

Figure 1 A Market with a Price Ceiling (a) A Price Ceiling That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity $4 Price ceiling Equilibrium price Demand Supply 3 100

Figure 1 A Market with a Price Ceiling Copyright©2003 Southwestern/Thomson Learning (b) A Price Ceiling That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply 2Price ceiling Shortage 75 Quantity supplied 125 Quantity demanded Equilibrium price $3

Price Gouging What is the difference between price gouging and acting in accordance with the laws of supply and demand? Should it be illegal?

Rent Control Ceiling or floor? Rationale? One economist called rent control “the best way to destroy a city, other than bombing.”

Figure 3 Rent Control in the Short Run and in the Long Run Copyright©2003 Southwestern/Thomson Learning (a) Rent Control in the Short Run (supply and demand are inelastic) Quantity of Apartments 0 Supply Controlled rent Rental Price of Apartment Demand Shortage

Figure 3 Rent Control in the Short Run and in the Long Run Copyright©2003 Southwestern/Thomson Learning (b) Rent Control in the Long Run (supply and demand are elastic) 0 Rental Price of Apartment Quantity of Apartments Demand Supply Controlled rent Shortage

Shortages and black markets will develop. The future supply of housing will decline. The quality of housing will deteriorate. Non-price methods of rationing will increase in importance. Effects of Rent Control Inefficient use of housing will result. Long-term renters will benefit at the expense of newcomers.

Figure 4 A Market with a Price Floor Copyright©2003 Southwestern/Thomson Learning (a) A Price Floor That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity 2 Price floor Equilibrium price Demand Supply $3 100

Figure 4 A Market with a Price Floor Copyright©2003 Southwestern/Thomson Learning (b) A Price Floor That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply $4 Price floor 80 Quantity demanded 120 Quantity supplied Equilibrium price Surplus 3

Minimum Wage

Figure 5 How the Minimum Wage Affects the Labor Market Copyright©2003 Southwestern/Thomson Learning Quantity of Labor Wage 0 Labor demand Labor Supply Equilibrium employment Equilibrium wage

Figure 5 How the Minimum Wage Affects the Labor Market Copyright©2003 Southwestern/Thomson Learning Quantity of Labor Wage 0 Labor Supply Labor surplus (unemployment) Labor demand Minimum wage Quantity demanded Quantity supplied

Taxes & Subsidies

Figure 6 A Tax on Buyers Copyright©2003 Southwestern/Thomson Learning Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium without tax Tax ($0.50) Price buyers pay D1D1 D2D2 Supply,S1S1 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). $ Equilibrium with tax

Figure 7 A Tax on Sellers Copyright©2003 Southwestern/Thomson Learning 2.80 Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Price without tax Price sellers receive Equilibrium with tax Equilibrium without tax Tax ($0.50) Price buyers pay S1S1 S2S2 Demand,D1D1 A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50) $

Figure 9 How the Burden of a Tax Is Divided Copyright©2003 Southwestern/Thomson Learning Quantity 0 Price Demand Supply Tax Price sellers receive Price buyers pay (a) Elastic Supply, Inelastic Demand the incidence of the tax falls more heavily on consumers When supply is more elastic than demand... Price without tax than on producers.

Figure 9 How the Burden of a Tax Is Divided Copyright©2003 Southwestern/Thomson Learning Quantity 0 Price Demand Supply Tax Price sellers receive Price buyers pay (b) Inelastic Supply, Elastic Demand than on consumers. 1. When demand is more elastic than supply... Price without tax the incidence of the tax falls more heavily on producers...

Tax Revenue If tax is $T per unit, tax revenue equals … TQ

Figure 2 Tax Revenue Copyright © 2004 South-Western Tax revenue (T × Q) Size of tax (T ) Quantity sold (Q) Quantity 0 Price Demand Supply Quantity without tax Quantity with tax Price buyers pay Price sellers receive

Recall … Consumer Surplus: Area under demand curve and above price line. Producer Surplus: Area above supply curve and below price line.

Figure 3 How a Tax Effects Welfare Copyright © 2004 South-Western A F B D C E Quantity 0 Price Demand Supply = PBPB Q2Q2 = PSPS Price buyers pay Price sellers receive = P1P1 Q1Q1 Price without tax

Deadweight Loss The fall in total surplus that results from a market distortion, such as a tax. Buyers have an incentive to consume less and sellers an incentive to produce less.

Ronald Reagan’s Deadweight Loss I came into the Big Money making pictures during WWII. You could only make four pictures and then you were in the top bracket. So we all quit working after four pictures and went off to the country.

Tax rate (percent) Tax revenues Maximum The Laffer Curve A C B

The average tax rate equals tax liability divided by taxable income. –A progressive tax is one in which the average tax rate rises with income. –A proportional tax is one in which the average tax rate stays the same across income levels. –A regressive tax is one in which the average tax rate falls with income. Average Tax Rate

Marginal tax rate: calculated as the change in tax liability divided by the change in taxable income. What is the tax on the last dollar earned? Marginal Tax Rate

2003 Tax Table Continued If line 40 (taxable income) is And you are At least But less than Single Married filing jointly Married filing separately Head of a house- hold $32,000 Your tax is … An excerpt from the 2003 federal income tax table is shown here. Note, for single individuals, as income increases from $32,000 to $32,100 … In this range, what is the individual’s marginal tax rate? What is the individual’s average income tax rate? their tax liability increases from $4,816 to $4,841.