Supply,

Demand,
and
Governmen
t Policies
6t
h Chapter
In this chapter,
we’ll discuss:
￮ Price Ceilings and Price Floors and its
examples
￮ How do price ceilings and price floor
affect market outcomes?
￮ How do the effects depend on whether
the tax is imposed on buyers or
sellers?
￮ How do taxes affect market outcomes?
￮ What is the incidence of a tax?
￮ Determination of the incidence of tax

3
4
Government Policies
That Alter the Private
Market Outcome
Price Control
Price Ceiling Price Floor Taxes
￮ A legal ￮ A legal ￮ Government's
maximum on minimum on policy to raise
the price of a the price of a revenue for
good or good or public projects.
service service ￮ The
￮ Example: Rent government
￮ Example: can make
Control Minimum buyers or
Wage sellers pay a
specific amount
on each unit
bought/sold.
5
Government Policies
That Alter the
Private Market
Outcome
We will use the supply/demand
model to see how each policy affects
the market outcome.

The price buyers pay, the price

sellers receive, and equilibrium price
and quantity.

6
 Example 1: The
Market for Rice
Price of
Rice

Equilibrium
Price and
Quantity of
Rice without Quantity
price control of Rice 7
 Example 1: The
Market for Rice

A Price
Ceiling
above the
equilibrium
price is
NOT
BINDING –
it has no
effect on the
price or
quantity
sold
8
 Example 1: The
Market for Rice
The
Equilibrium
Price ($800)
is above the
ceiling
therefore
illegal.

The ceiling is a
BINDING
CONSTRAINT
on the price,
causes a
SHORTAGE.

9
 Example 1: The
Market for Rice
In the long
run, supply
and
demand are
more price-
elastic.

So, the
shortage is
larger

10
Shortages and
Rationing
￮ With a shortage, sellers must ration
the goods among the buyers, in this
case, rice.
￮ Some rationing mechanism:
1. Long lines
2. Discrimination according to
sellers’ biases
￮ These mechanisms are often unfair,
and inefficient

11
Shortages and
Rationing
￮ For example, the goods do not
necessarily go to the buyers who
value them most highly.

￮ In contrast, when prices are not

controlled, the rationing mechanism is
efficient (the goods go to the buyer
that value them the most highly) and
impersonal (and thus fair).

12
 Example 1: The
Market for Unskilled
Labor
Wage
paid to
the
unskilled
workers

Equilibrium
Price and
Quantity
without price Quantity of unskilled
control workers 13
 Example 1: The
Market for Unskilled
Labor

A price floor
below the
equilibrium
price is NOT
BINDING

- It has no
effect on the
market
outcome

14
 Example 1: The
Market for Unskilled
Labor
The equilibrium
wage ($4) is
below the floor
and therefore
illegal.

The floor is a
BINDING
CONSTRAINT
on the wage,
causes a
suplus (i.e.,
unemployment)
15
 Example 1: The
Market for Unskilled
Labor
Minimum
Minimum wage
wage
laws
laws do
do not
not
affect
affect highly
highly
skilled
skilled workers.
workers.

They
They do
do affect
affect
unskilled
unskilled
workers
workers

Studies:
Studies: A A 10%
10%
in
in the
the min.
min.
wage
wage raises
raises
teen
teen
unemployment
unemployment
by
by 1-3%.
1-3%. 16
17
18
19
20
Evaluating Price
Controls
￮ Recall one of the Ten Principles from
Chapter 1:
￮ Markets are usually a good way to
organize economic activity.
￮ Prices are the signals that guide the
allocation of society’s resources. This
allocation is altered when policymakers
restrict prices.
￮ Price controls often intended to help the
poor, but often hurt more than help.

21
Taxes
￮ The government levies taxes on many
goods & services to raise revenue to pay
for national defense, public schools, etc.
￮ The government can make buyers or
sellers pay the tax
￮ The tax can be a % of the good’s price, or
a specific amount for each unit sold.

￮ For the following example, we analyze

per-unit taxes only, for simplicity.

22
 Example 3: The Market for
Pizza

Equilibrium
Price and
Quantity without
Tax

23
Example 3: The Market for
Pizza

24
Example 3: The Market for
Pizza

25
Example 3: The Market for
Pizza

26
Example 3: The Market for
Pizza

27
Example 3: The Market for
Pizza

28
Example 3: The Market for
Pizza

29
30
31
Elasticity and Tax Incidence

32
Elasticity and Tax Incidence

33
Conclusion

34
Chapter Summary

35
Chapter Summary

36
The End

37