1. Harcourt Brace & Company Chapter 6 Supply, Demand, and Government Policies

2. Harcourt Brace & Company 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, every buyer or seller may not be satisfied. Hence, market controls!

3. Harcourt Brace & Company Market Price Controls u Are usually enacted when policymakers believe that the market price is unfair to buyers and sellers. u Result in governmental policies, i.e., price ceilings and floors.

4. Harcourt Brace & Company Price Ceilings & Price Floors u A Price Ceiling –is a legally established maximum price which a seller can charge or a buyer must pay. u A Price Floor –is a legally established minimum price which a seller can charge or a buyer must pay.

5. Harcourt Brace & Company Price Ceilings u When the government imposes a price ceiling, a legal maximum on the price, a shortage results, if the price is set below equilibrium price.

6. Harcourt Brace & Company Market Impacts of a Price Ceiling Supply Demand Price Quantity Equilibrium Price Equilibrium Quantity

7. Harcourt Brace & Company A Price Ceiling Supply Demand Price Quantity PEPE QEQE Price Ceiling PCPC

8. Harcourt Brace & Company A Price Ceiling Creates Shortages. Supply Demand Price Quantity PEPE QEQE PCPC QSQS QDQD

9. Harcourt Brace & Company A Price Ceiling Creates Shortages. Supply Demand Price Quantity PEPE QEQE PCPC QSQS QDQD Shortage

10. Harcourt Brace & Company Market Impacts of a Price Ceiling u A Price Ceiling creates... –Shortages (Qty Demanded > Qty Supplied) v Gasoline shortages of the 1970s –Non-Price Rationing - An alternative mechanism for rationing of the good: v Long Lines (First-In-Line, Figure 6-2)

11. Harcourt Brace & Company Price Floors u When the government imposes a price floor, a legal minimum price, causes a surplus if the price is set above equilibrium price.

12. Harcourt Brace & Company A Price Floor Supply Demand Price Quantity PEPE QEQE Price Floor PFPF

13. Harcourt Brace & Company Market Impacts of a Price Floor u A government imposed price floor hinders the forces of supply and demand in moving toward the equilibrium price and quantity. u When the market price hits the floor, it can fall no further and the market price equals the floor price. A price floor causes a surplus.

14. Harcourt Brace & Company A Price Floor Creates a Surplus. Supply Demand Price Quantity PEPE QEQE PFPF QSQS QDQD

15. Harcourt Brace & Company A Price Floor Creates a Surplus. Supply Demand Price Quantity PEPE QEQE PFPF QSQS QDQD Surplus

16. Harcourt Brace & Company Market Impacts of a Price Floor u A Price Floor creates... –Surpluses (Qty Supplied > Qty Demanded) –Non-Price Rationing - An alternative mechanism for rationing of the good: v Discrimination Criteria –Examples: v Minimum Wage v Agricultural Price Supports

17. Harcourt Brace & Company Taxes! Taxes! Taxes! u What is the purpose of government imposed taxes? –To raise government revenues. –To restrict allocation of a product. u What is an excise tax? –A “per-unit” tax that’s independent of the price of the product.

18. Harcourt Brace & Company Taxes! Taxes! Taxes! u Who pays the tax on a good? The buyer or the seller? u How is the burden of a tax divided between buyer and seller?

19. Harcourt Brace & Company 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.

20. Harcourt Brace & Company The Incidence of Tax...How is the burden of the tax distributed? u Consider a tax levied on sellers of a good. u How do effects of the tax levied on the seller compare with those of the effects imposed on the buyer?

21. Harcourt Brace & Company Tax on Sellers u Supply falls u Quantity falls u Price that the buyer pays rises u The return to the seller falls

22. Harcourt Brace & Company 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!

23. Harcourt Brace & Company Elasticity and Taxes u The more INELASTIC the demand and the more ELASTIC the supply results in the consumer paying more of the tax. u The more ELASTIC the demand and the more INELASTIC the supply results in the supplier paying more of the tax.

24. Harcourt Brace & Company Elasticity and Excise Tax Example: A more inelastic demand and more elastic supply. Supply Demand $2.00 250

25. Harcourt Brace & Company Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.00 $2.15 200250

26. Harcourt Brace & Company Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.15 $2.00 $1.95 200250 Seller’s burden of tax

27. Harcourt Brace & Company Elasticity and Excise Tax S1 Demand S2 Specific Tax $.20 $2.15 $2.00 $1.95 200250 Buyer’s burden of tax

28. Harcourt Brace & Company Supply, Demand & Government u The economy is governed by two kinds of laws: –The laws of supply and demand –The laws enacted by government. u Price controls and taxes are common in various markets in the economy: –Price Ceilings –Price Floors –Excise Tax