Copyright © 2004 South-Western Ch. 4a: Economic efficiency, Government Price Setting, and Taxes 1.Price Ceilings- A legally set maximum price below the market equilibrium price that sellers may charge for a good or service. 2.Governments set a maximum price below the market equilibrium price (binding price ceiling) to help consumers 3.Examples: Rent control in NYC, or Berkley; Sport salary caps, Home owner’s insurance control; and gasoline price controls in the 1970s. ■The results were long lines at service stations. ■Service stations were forced to close because they had no gasoline (shortage). 1.Price Ceilings- A legally set maximum price below the market equilibrium price that sellers may charge for a good or service. 2.Governments set a maximum price below the market equilibrium price (binding price ceiling) to help consumers 3.Examples: Rent control in NYC, or Berkley; Sport salary caps, Home owner’s insurance control; and gasoline price controls in the 1970s. ■The results were long lines at service stations. ■Service stations were forced to close because they had no gasoline (shortage).

Copyright © 2004 South-Western S D Pceiled Pe Binding Price Ceiling

Copyright © 2004 South-Western Price Ceiling 4. A binding price ceiling results in a shortage because buyers want more than what sellers are willing to offer Shortage = Q d -Q s 5. Government must institute some rationing system to deal with the shortage  First-come, first-served  Rationing tickets or cards 4. A binding price ceiling results in a shortage because buyers want more than what sellers are willing to offer Shortage = Q d -Q s 5. Government must institute some rationing system to deal with the shortage  First-come, first-served  Rationing tickets or cards

Copyright © 2004 South-Western Binding vs non-binding price ceiling 6. A binding price-ceiling occurs when the price is set below the market eq. price A binding price-ceiling benefits the consumers in the short-run. A non-binding price-ceiling occurs when the price is set above the market eq. price. 6. A binding price-ceiling occurs when the price is set below the market eq. price A binding price-ceiling benefits the consumers in the short-run. A non-binding price-ceiling occurs when the price is set above the market eq. price.

Copyright © 2004 South-Western A Non-Binding Price Ceiling Price Quantity Supply P Ceiled PEPE QEQE Price Ceiling Demand

Copyright © 2004 South-Western 6. Price Floors (support) 7. Price floor- a legally set minimum price above the market eq. price (binding price floor) that sellers are guaranteed to charge Note: The purpose of price support(floor) is to help producers 7. Price floor- a legally set minimum price above the market eq. price (binding price floor) that sellers are guaranteed to charge Note: The purpose of price support(floor) is to help producers

Copyright © 2004 South-Western A Binding Price Floor Price Quantity Supply PFPF PEPE QEQE Price Floor Demand

Copyright © 2004 South-Western A Binding Price Floor 8. Examples  Dairy price support  Tobacco price support  Minimum wage laws- Economists disagree about the effects of minimum wage. Some say it reduces employment; others say, it has no effect on employment. It depends on the labor market type 9. The government sets a legal minimum above the market equilibrium price for dairy, tobacco, soybeans, etc. to help producers 10. Price floor or support will result in a surplus. 8. Examples  Dairy price support  Tobacco price support  Minimum wage laws- Economists disagree about the effects of minimum wage. Some say it reduces employment; others say, it has no effect on employment. It depends on the labor market type 9. The government sets a legal minimum above the market equilibrium price for dairy, tobacco, soybeans, etc. to help producers 10. Price floor or support will result in a surplus.

Copyright © 2004 South-Western 11. Binding and Non-binding Price Floor or Support ●A binding price floor occurs when price set above the market equilibrium price. ●A non-binding price floor occurs when price set below the market equilibrium price. ●Example: Impact of minimum wage policy on manufacturing wage and employment ●A binding price floor occurs when price set above the market equilibrium price. ●A non-binding price floor occurs when price set below the market equilibrium price. ●Example: Impact of minimum wage policy on manufacturing wage and employment

Copyright © 2004 South-Western Example of Minimum Prices: The Federal Minimum Wage ●The federal minimum wage was established by the Fair Labor Standards Act of Originally the minimum wage was set at $0.25 per hour and covered approximately 43 percent of all non-supervisory employees in private nonagricultural jobs.

Copyright © 2004 South-Western Minimum Wage Legislation ●The law was last amended in August 1996 when the existing minimum of $4.25 was raised in two steps, to $4.75 on October 1, 1996, and then to $5.15 on September 1, ●The current law provides for a “training wage” of $4.25 per hour for teenagers in the first 90 days of employment. ●Approximately 90 percent of the labor force is now covered. ●The law was last amended in August 1996 when the existing minimum of $4.25 was raised in two steps, to $4.75 on October 1, 1996, and then to $5.15 on September 1, ●The current law provides for a “training wage” of $4.25 per hour for teenagers in the first 90 days of employment. ●Approximately 90 percent of the labor force is now covered.

Copyright © 2004 South-Western Minimum Wage Legislation ●Most states have established their own laws that extend minimum wages to workers not covered by federal law and in a few instances sets the level above the federal level. ●Economists disagree about the impact of minimum wage laws, but the latest increase probably had a small effect on employment. ●Most states have established their own laws that extend minimum wages to workers not covered by federal law and in a few instances sets the level above the federal level. ●Economists disagree about the impact of minimum wage laws, but the latest increase probably had a small effect on employment.

Copyright © 2004 South-Western Agricultural Prices ●Milk ●The Freedom to Farm Act and recent developments ●Milk ●The Freedom to Farm Act and recent developments

Copyright © 2004 South-Western Price floor 10. A binding price floor results in a surplus because sellers are willing to offer more than what buyers can afford to buy at a price above the eq. price Surplus = Q s –Q d 11. A binding price floor occurs when price is set above the equilibrium price A non-binding price floor occurs when price is set below the equilibrium price 12. The effect of the minimum wage depends on the type of labor market (youth vs skilled workers). It reduces the employment of the youth and has no immediate effect on the employment of skilled workers 10. A binding price floor results in a surplus because sellers are willing to offer more than what buyers can afford to buy at a price above the eq. price Surplus = Q s –Q d 11. A binding price floor occurs when price is set above the equilibrium price A non-binding price floor occurs when price is set below the equilibrium price 12. The effect of the minimum wage depends on the type of labor market (youth vs skilled workers). It reduces the employment of the youth and has no immediate effect on the employment of skilled workers

Copyright © 2004 South-Western 13. Taxes ●How do taxes affect the decisions of buyers and sellers? ●Tax incidence is burden of taxation. ●How do taxes affect the decisions of buyers and sellers? ●Tax incidence is burden of taxation.

Copyright © 2004 South-Western Taxes: Impact of a 50 Cent Tax from Buyer’s Viewpoint From the buyer’s viewpoint, the tax causes the demand curve to shift down by 50 cents $3.30 $3.00 $2.80

Copyright © 2004 South-Western Taxes: Impact of a 50 Cent Tax from Buyer’s Viewpoint $3.30 $3.00 $2.80 The tax increases the market price to the buyer and decreases demand.

Copyright © 2004 South-Western Taxes: Impact of a 50 Cent Tax from Buyer’s Viewpoint $3.30 $3.00 $2.80 The tax decreases the return to the seller.

Copyright © 2004 South-Western Taxes: Impact of a 50 Cent Tax from Buyer’s Viewpoint $3.30 $3.00 $2.80 The tax makes both the buyer and the seller worse off!

Copyright © 2004 South-Western Prohibitions and Rationing ●What is the effect on the demand for goods and services that are prohibited? ■Embargoes ■Street drugs ■Prohibition (18 th Amendment to the U.S. Constitution) ●What is the effect on the demand for goods and services that are prohibited? ■Embargoes ■Street drugs ■Prohibition (18 th Amendment to the U.S. Constitution)

Copyright © 2004 South-Western The Impact of an Excise Tax – Sellers Collect the Tax Specific Tax $.50

Copyright © 2004 South-Western Examples of Taxes & Subsidies ●Taxes ■What happens to the supply of cigarettes if the taxes per pack are increased? ■Why do the anti-smokers want to increase the Federal tax on cigarettes? ■Tax subsidy ●Taxes ■What happens to the supply of cigarettes if the taxes per pack are increased? ■Why do the anti-smokers want to increase the Federal tax on cigarettes? ■Tax subsidy

Copyright © 2004 South-Western Examples of Tax & Subsidies ●A subsidy is like a negative tax; instead of raising the price, it lowers the price. ●How is the demand for higher education affected as the public subsidy increases or decreases? ●In 1996 the farm subsidy changed radically (decreased). ●One exception is Tobacco Farming. ●A subsidy is like a negative tax; instead of raising the price, it lowers the price. ●How is the demand for higher education affected as the public subsidy increases or decreases? ●In 1996 the farm subsidy changed radically (decreased). ●One exception is Tobacco Farming.

Copyright © 2004 South-Western Elasticity and Tax Incidence ●The more realistic the demand for the product, the more the burden falls on buyers. ●The more elastic the demand for the product, the more the burden falls on sellers. ●The more inelastic the supply of the product, the more the burden falls on sellers. ●The more realistic the demand for the product, the more the burden falls on buyers. ●The more elastic the demand for the product, the more the burden falls on sellers. ●The more inelastic the supply of the product, the more the burden falls on sellers.

Copyright © 2004 South-Western Elasticity and Tax Incidence Price Quantity Tax paid by buyer Tax paid by seller Amt. of tax

Copyright © 2004 South-Western Other Government Policies ●Regulation (cigarettes) ■What happens to the supply of automobiles if new environmental regulations are imposed? ■Truck safety ■What happens to the demand for goods and services that are prohibited? ●Milk and marketing orders ●Airports ●Regulation (cigarettes) ■What happens to the supply of automobiles if new environmental regulations are imposed? ■Truck safety ■What happens to the demand for goods and services that are prohibited? ●Milk and marketing orders ●Airports