Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Chapter 6 Supply, Demand, and Government Policies © 2002 by Nelson, a division of Thomson Canada Limited

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Overview  The Effects of Price Controls  The Effects of an Excise Tax

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply, Demand and Government Policies In a “free”, unregulated market system, market forces establish equilibrium prices and exchange quantities. While equilibrium conditions may be efficient it may be true that not everyone, i.e. buyer or seller are satisfied. Hence, market controls!

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Price Controls  Are usually enacted when policy-makers believe that the market price is unfair to buyers and sellers.  Result in government policies, i.e. price ceilings and floors.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Price Ceilings & Price Floors  A Price Ceiling – is a legally established maximum price which a seller can charge or a buyer must pay.  A Price Floor – is a legally established minimum price which a seller can charge or a buyer must pay.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Price Ceilings  When the government imposes a price ceiling (i.e... a legal maximum on the price at which a good can be sold) two outcomes are possible: 1. The price ceiling is not binding. 2. The price ceiling is a binding constraint on the market, creating Shortages.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Ceiling Supply Demand Price Quantity Equilibrium Price Equilibrium Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Non-Binding Price Ceiling Supply Demand Price Quantity PEPE QEQE Price Ceiling PCPC

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Ceiling Supply Demand Price Quantity PEPE QEQE Price Ceiling PCPC

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Ceiling Creates Shortages. Supply Demand Price Quantity PEPE QEQE PCPC QSQS QDQD

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Ceiling Creates Shortages. Supply Demand Price Quantity PEPE QEQE PCPC QSQS QDQD Shortage

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Ceiling  A Binding Price Ceiling creates... – Shortages (i.e... Demand > Supply)  Gasoline shortages of the 1970s  Housing shortages with rent controls – Non-Price Rationing - An alternative mechanism for rationing of the good:  Long Lines (first-In-Line, friends etc.)  Discrimination criteria set by seller  Black markets

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Price Floors  When the government imposes a price floor (i.e... a legal minimum on the price at which a good can be sold) two outcomes are possible: 1. The price floor is not binding. 2. The price floor is a binding constraint on the market, creating Surpluses.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Non-Binding Price Floor Supply Demand Price Quantity PEPE QEQE Price Floor PFPF

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Floor Supply Demand Price Quantity PEPE QEQE Price Floor PFPF

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Floor  A government-imposed market price floor hinders the forces of supply and demand in moving toward the equilibrium price and quantity.  When the market price hits the floor, it can fall no further and the market price equals the floor price. A binding price floor causes a surplus.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition A Binding Price Floor Creates a Surplus. Supply Demand Price Quantity PEPE QEQE PFPF QSQS QDQD

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply Demand Price Quantity PEPE QEQE PFPF QSQS QDQD Surplus A Binding Price Floor Creates a Surplus.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Market Impacts of a Price Floor  A Binding Price Floor creates... – Surpluses (i.e. Quantity Supplied > Quantity Demanded) – Non-Price Rationing - An alternative mechanism for rationing of the good:  Discrimination Criteria – Examples:  Minimum Wage  Agricultural Price Supports

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Quick Quiz!  Define “price ceiling” and “price floor”  Give an example of each.  Which leads to a shortage, which a surplus? Why?

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Overview The Effects of Price Controls  The Effects of an Excise Tax

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes! Taxes! Taxes!  What is the purpose of government- imposed taxes? – To raise government revenues. – To restrict production of a product.  What is an excise tax? – A “per-unit” tax that’s independent of the price of the product.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes! Taxes! Taxes!  Who pays the tax on a good? The buyer or the seller?  How is the burden of a tax divided between buyer and seller?  When the government levies a tax on a good, the equilibrium quantity of the good falls. The size of the market for that good shrinks, shifting either the demand or supply curve.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact  Taxes discourage market activity. The quantity of the good sold is smaller than without the tax. Buyers and sellers share the tax burden.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1S1 $ D1D1 Equilibrium without tax Quantity Price

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1S1 $ D1D1 From the sellers viewpoint, the tax causes the demand curve to shift down by 50 cents. $ Price Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1S1 $ $ The tax increases the market price to the buyer... $2.80 D1D1 Quantity Price

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1S1 $ $ The tax increases the market price to the buyer... …in this case the price rises $.30. $2.80 D1D1 Price Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1S1 $ $ The tax decreases the return to the seller as the seller gets $.20 less. $2.80 D1D1 Quantity Price

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Taxes: Impact From a 50 Cent Tax S1S1 $ $ The tax makes both the buyer and the seller worse off! $2.80 D1D1 Quantity Price

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition The Incidence of Tax...How is the burden of the tax distributed?  Consider a tax levied on sellers of a good. What are the effects of this tax?  How do effects of the tax levied on the seller compare with those of the effects imposed on the buyer?  Depends on Elasticity of Demand and Elasticity of Supply.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition The Incidence of Tax...How is the burden of the tax distributed? The burden of a tax falls on the side of the market with the smaller price elasticity!

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Taxes  The more inelastic the demand and the more elastic the supply results in the consumer paying more of the tax.  The more elastic the demand and the more inelastic the supply results in the supplier paying more of the tax.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax Example: A more inelastic demand and more elastic supply. Supply Demand $ Price Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.00 $ Price Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.15 $2.00 $ Producer’s burden of tax Price Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.15 $2.00 $ Buyer’s burden of tax Price Quantity

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Quick Quiz  Show how a tax on car buyers of $1,000 per car affects the quantity of cars sold and the price of cars.  Show how a similar tax on car sellers affects quantity and price.

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Supply, Demand & Government  The economy is governed by two kinds of laws: – The laws of supply and demand – The laws enacted by government  Price controls and taxes are common in various markets in the economy: – Price Ceilings – Price Floors – Excise Tax

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Overview The Effects of Price Controls The Effects of an Excise Tax