Supply,Demand,and

GovernmentPoliciesEconomicsPRINCIPLESOFN.GregoryMankiw6Inthischapter,

lookfortheanswerstothesequestions:Whatarepriceceilingsandpricefloors?

Whataresomeexamplesofeach?Howdopriceceilingsandpricefloorsaffectmarketoutcomes?Howdotaxesaffectmarketoutcomes?

Howdotheeffectsdependonwhether

thetaxisimposedonbuyersorsellers?Whatistheincidenceofatax?

Whatdeterminestheincidence?1SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES2GovernmentPoliciesThatAlterthe

PrivateMarketOutcomePricecontrolsPriceceiling:alegalmaximumontheprice

ofagoodorserviceExample:rentcontrol

Pricefloor:alegalminimumonthepriceof

agoodorserviceExample:minimumwage

TaxesThegovtcanmakebuyersorsellerspayaspecificamountoneachunitbought/sold.Wewillusethesupply/demandmodeltosee

howeachpolicyaffectsthemarketoutcome

(thepricebuyerspay,thepricesellersreceive,andeq’mquantity).SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES3EXAMPLE1:TheMarketforApartmentsEq’mw/o

pricecontrolsPQDSRentalpriceofapts$800300QuantityofapartmentsSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES4HowPriceCeilingsAffectMarketOutcomesApriceceiling

abovethe

eq’mpriceis

notbinding–

hasnoeffect

onthemarketoutcome.PQDS$800300Price

ceiling$1000SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES5HowPriceCeilingsAffectMarketOutcomesTheeq’mprice($800)isabovetheceilingandthereforeillegal.Theceiling

isabindingconstraint

ontheprice,causesashortage.PQDS$800Price

ceiling$500250400shortageSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES6HowPriceCeilingsAffectMarketOutcomesInthelongrun,supplyanddemand

aremore

price-elastic.So,theshortage

islarger.PQDS$800150Price

ceiling$500450shortageSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES7ShortagesandRationingWithashortage,sellersmustrationthegoodsamongbuyers.Somerationingmechanisms:(1)Longlines

(2)Discriminationaccordingtosellers’biasesThesemechanismsareoftenunfair,andinefficient:thegoodsdonotnecessarilygotothebuyerswhovaluethemmosthighly.Incontrast,whenpricesarenotcontrolled,

therationingmechanismisefficient(thegoods

gotothebuyersthatvaluethemmosthighly)

andimpersonal(andthusfair).SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES8EXAMPLE2:TheMarketforUnskilledLaborEq’mw/o

pricecontrolsWLDSWagepaidtounskilledworkers$4500QuantityofunskilledworkersSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES9HowPriceFloorsAffectMarketOutcomesWLDS$4500Price

floor$3Apricefloor

belowthe

eq’mpriceis

notbinding–

hasnoeffect

onthemarketoutcome.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES10HowPriceFloorsAffectMarketOutcomesWLDS$4Price

floor$5Theeq’mwage($4)isbelowthefloorandtherefore

illegal.Thefloor

isabindingconstraint

onthewage,

causesa

surplus(i.e.,unemployment).400550laborsurplusSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES11Minwagelaws

donotaffect

highlyskilledworkers.Theydoaffectteenworkers.Studies:

A10%increase

intheminwageraisesteenunemployment

by1-3%.TheMinimumWageWLDS$4Min.wage$5400550unemp-loymentACTIVELEARNING1

PricecontrolsQPS0Themarketfor

hotelroomsDDetermine

effectsof:A.

$90price

ceilingB. $90price

floorC. $120price

floor12SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES13EvaluatingPriceControlsRecalloneoftheTenPrinciplesfromChapter1:

Marketsareusuallyagoodway

toorganizeeconomicactivity.

Pricesarethesignalsthatguidetheallocationofsociety’sresources.Thisallocationisalteredwhenpolicymakersrestrictprices.Pricecontrolsoftenintendedtohelpthepoor,

butoftenhurtmorethanhelp.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES14TaxesThegovtleviestaxesonmanygoods&servicestoraiserevenuetopayfornationaldefense,publicschools,etc.Thegovtcanmakebuyersorsellerspaythetax.Thetaxcanbea%ofthegood’sprice,

oraspecificamountforeachunitsold.Forsimplicity,weanalyzeper-unittaxesonly.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES15S1EXAMPLE3:TheMarketforPizzaEq’m

w/otaxPQD1$10.00500SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES16S1D1$10.00500ATaxonBuyersThepricebuyerspay

isnow$1.50higherthanthemarketpriceP.Pwouldhavetofall

by$1.50tomake

buyerswilling

tobuysameQ

asbefore.E.g.,ifPfalls

from$10.00to$8.50,

buyersstillwillingto

purchase500pizzas.PQD2Effectsofa$1.50perunittaxonbuyers$8.50Hence,ataxonbuyersshiftstheDcurvedownbytheamountofthetax.TaxSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES17S1D1$10.00500ATaxonBuyersPQD2$11.00PB=$9.50PS=TaxEffectsofa$1.50perunittaxonbuyersNeweq’m:Q=450Sellers

receive

PS=$9.50Buyerspay

PB=$11.00Differencebetweenthem

=$1.50=tax450SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES18450S1TheIncidenceofaTax:howtheburdenofataxissharedamong

marketparticipantsPQD1$10.00500D2$11.00PB=$9.50PS=TaxInourexample,buyerspay

$1.00more,sellersget

$0.50less.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES19S1ATaxonSellersPQD1$10.00500S2Effectsofa$1.50perunittaxonsellersThetaxeffectivelyraisessellers’costsby

$1.50perpizza.Sellerswillsupply

500pizzas

onlyif

Prisesto$11.50,

tocompensatefor

thiscostincrease.$11.50Hence,ataxonsellersshiftsthe

Scurveupbytheamountofthetax.TaxSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES20S1ATaxonSellersPQD1$10.00500S2450$11.00PB=$9.50PS=TaxEffectsofa$1.50perunittaxonsellersNeweq’m:Q=450Buyerspay

PB=$11.00Sellers

receive

PS=$9.50Differencebetweenthem

=$1.50=taxSUPPLY,DEMAND,ANDGOVERNMENTPOLICIES21S1TheOutcomeIstheSameinBothCases!Whatmattersisthis:Ataxdrives

awedgebetweenthepricebuyerspayandthepricesellersreceive.PQD1$10.00500450$9.50$11.00PB=PS=TaxTheeffectsonPandQ,andthetaxincidencearethesamewhetherthetaxisimposedonbuyersorsellers!ACTIVELEARNING2

EffectsofataxQPS0Themarketfor

hotelroomsDSupposegovtimposesataxonbuyersof$30perroom.Findnew

Q,PB,PS,

andincidenceoftax.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES23ElasticityandTaxIncidenceCASE1:SupplyismoreelasticthandemandPQDSTaxBuyers’shareoftaxburdenSellers’shareoftaxburdenPriceifnotaxPBPSIt’seasier

forsellersthanbuyerstoleavethemarket.Sobuyersbearmostoftheburden

ofthetax.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES24ElasticityandTaxIncidenceCASE2:DemandismoreelasticthansupplyPQDSTaxBuyers’shareoftaxburdenSellers’shareoftaxburdenPriceifnotaxPBPSIt’seasierforbuyersthansellerstoleavethemarket.Sellersbearmostoftheburdenof

thetax.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES25CASESTUDY:WhoPaystheLuxuryTax?1990:Congressadoptedaluxurytaxonyachts,privateairplanes,furs,expensivecars,etc.Goalofthetax:raiserevenuefromthose

whocouldmosteasilyaffordtopay–

wealthyconsumers.Butwhoreallypaysthistax?SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES26CASESTUDY:WhoPaystheLuxuryTax?ThemarketforyachtsPQDSTaxBuyers’shareoftaxburdenSellers’shareoftaxburdenPBPSDemandis

price-elastic.Intheshortrun,supplyisinelastic.Hence,

companiesthatbuildyachtspaymostof

thetax.SUPPLY,DEMAND,ANDGOVERNMENTPOLICIES27CONCLUSION:GovernmentPoliciesandtheAllocationofResourcesEachofthepoliciesinthischapteraffectstheallocationofsociety’sresources.Example1:Ataxonpizzareduceseq’mQ. Withlessproductionofpizza,resources(workers,ovens,cheese)willbecomeavailabletootherindustries.Example2:Abindingminimumwagecauses

asurplusofworkers,awasteofresources.So,it’simpor