N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eighth Edition

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eighth Edition

N. GREGORY MANKIW PRINCIPLES OF ECONOMICS Eighth Edition CHAPTER 6 Supply, Demand, and Government Policies Premium PowerPoint Slides by: V. Andreea CHIRITESCU Eastern Illinois University 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 1 Look for the answers to these questions: What are price ceilings and price floors? What are some examples of each? How do price ceilings and price floors affect market outcomes? How do taxes affect market outcomes?

How do the effects depend on whether the tax is imposed on buyers or sellers? What is the incidence of a tax? What determines the incidence? 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 2 Government Policies That Alter the Private Market Outcome Price controls Price ceiling: legal maximum on the price at which a good can be sold Rent-control laws Price floor: legal minimum on the price at which a good can be sold Minimum wage laws Taxes: government can make buyers or sellers pay a specific amount on each unit 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 3

ASK THE EXPERTS Rent Control Local ordinances that limit rent increases for some rental housing units, such as in New York and San Francisco, have had a positive impact over the past three decades on the amount and quality of broadly affordable rental housing in cities that have used them. 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 4 EXAMPLE 1: The Market for Apartments Rental price of apartments P S Equilibrium without price controls

$800 D 300 Q Quantity of apartments 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 5 How Price Ceilings Affect Market Outcomes P A price ceiling above the equilibrium price is not binding has no effect on the market outcome. S Price

ceiling $1000 $800 D 300 Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 6 How Price Ceilings Affect Market Outcomes The equilibrium price ($800) is above the ceiling and therefore illegal. The price ceiling is binding, causes a shortage. P S

$800 Price ceiling $500 shortage 250 400 D Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 7 How Price Ceilings Affect Market Outcomes In the long run, supply and demand of rental apartments are more priceelastic. P

S $800 Price ceiling $500 So, the shortage is larger. shortage 150 450 D Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 8 Shortages and Rationing Because of shortage Sellers must ration the goods among buyers

Some rationing mechanisms: Long lines Discrimination according to sellers biases Are often unfair and inefficient The goods do not necessarily go to the buyers who value them most highly 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 9 EXAMPLE 2: The Market for Unskilled Labor Wage paid to unskilled workers W S Equilibrium without price controls $6.00

D 500 L Quantity of unskilled workers 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 10 How Price Floors Affect Market Outcomes W A price floor below the equilibrium price is not binding has no effect on the market outcome. S $6.00 Price floor

$5.00 D 500 L 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 11 How Price Floors Affect Market Outcomes The equilibrium wage ($6) W is below the floor and therefore illegal. $7.25 The price floor is binding, causes a surplus (i.e., $6.00 unemployment). Minimum wage laws do not affect highly skilled workers. They do affect teen workers. A 10% increase in the minimum wage raises teen unemployment by 13%.

labor surplus S Price floor D 400 550 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning L 12 ASK THE EXPERTS The Minimum Wage If the federal minimum wage is raised gradually to $15-per-hour by 2020, the employment rate for low-wage U.S. workers will be substantially lower than it would be under the status quo. 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.

13 Active Learning 1 The market for hotel P 140 rooms is in equilibrium 130 as in the graph. Determine the effects of: A. $90 price ceiling B. $90 price floor C. $120 price floor Price controls The market for hotel rooms S 120 110 100 90 80

D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 14 Active Learning 1 The price falls to $90. (binding price ceiling below the equilibrium) Buyers demand 120 rooms, sellers supply 90, leaving a shortage. A. $90 price ceiling P

140 The market for hotel rooms S 130 120 110 100 90 80 70 Price ceiling D shortage = 30 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning

15 Active Learning 1 B. $90 price floor P 140 Equilibrium price is above the $90 price floor, so the price floor is not binding. P = $100, Q = 100 rooms. The market for hotel rooms 130 S 120 110 100 90 Price floor

80 D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 16 Active Learning 1 C. $120 price floor P 140 The price rises to $120. (binding price floor above the equilibrium) 130

Buyers demand 60 rooms, sellers supply 120, causing a surplus. 90 120 110 The market for hotel rooms surplus = 60 S Price floor 100 80 D 70 60 50 40 0

Q 50 60 70 80 90 100 110 120 130 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 17 Evaluating Price Controls Markets are usually a good way to organize economic activity Economists usually oppose price ceilings and price floors Prices are not the outcome of some haphazard process Prices have the crucial job of balancing supply and demand Coordinating economic activity 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 18 Evaluating Price Controls Governments can sometimes improve market outcomes Want to use price controls Because of unfair market outcome

Aimed at helping the poor Often hurt those they are trying to help Other ways of helping those in need Rent subsidies Wage subsidies (earned income tax credit) 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 19 Taxes Government uses taxes To raise revenue for public projects Roads, schools, and national defense Tax incidence Manner in which the burden of a tax is shared among participants in a market The government can make the seller or the buyer to pay the tax 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 20

EXAMPLE 3: The Market for Pizza P Equilibrium without tax S1 $10.00 D1 500 Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 21 A Tax on Buyers Hence, a tax on buyers shifts the D curve down by the amount of the tax. Effects of a $1.50 per unit tax on buyers P

S1 $10.00 Tax $8.50 D1 D2 500 The price buyers pay is now $1.50 higher than the market price P. P would have to fall by $1.50 to make buyers willing to buy same Q as before. E.g., if P falls from $10.00 Q to $8.50, buyers are still willing to purchase 500 pizzas. 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 22 A Tax on Buyers Effects of a $1.50 per

unit tax on buyers P PB = $11.00 Tax S1 $10.00 PS = $9.50 D1 D2 450 500 New equilibrium: Q = 450 Sellers receive PS = $9.50 Buyers pay PB = $11.00 Difference between them = $1.50 = tax Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 23

The Incidence of a Tax: how the burden of a tax is shared among market participants In our example, buyers pay $1.00 more, P PB = $11.00 Tax S1 $10.00 PS = $9.50 sellers get $0.50 less. D1 D2 450 500 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning

Q 24 A Tax on Sellers Effects of a $1.50 per unit tax on sellers $11.50 P S2 Tax S1 The tax effectively raises sellers costs by $1.50 per pizza. Sellers will supply 500 pizzas only if P rises to $11.50, to compensate for this cost increase. Hence, a tax on sellers shifts the S curve up by D1 the amount of the tax. $10.00 500

Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 25 A Tax on Sellers Effects of a $1.50 per unit tax on sellers P PB = $11.00 S2 Tax New equilibrium: Q = 450 Buyers pay PB = $11.00 Sellers receive PS = $9.50 Difference between them = $1.50 = tax S1

$10.00 PS = $9.50 D1 450 500 Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 26 The Outcome Is the Same in Both Cases! The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers! P PB = $11.00 A tax drives a wedge between the price buyers pay and the price sellers receive. Tax S1

$10.00 PS = $9.50 D1 450 500 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. Q 27 Active Learning 2 The market for hotel P 140 rooms is in equilibrium 130 as in the graph. Suppose the Effects of a tax The market for hotel rooms 120 110 government

100 imposes a tax on 90 buyers of $30 per 80 room Find the new Q, PB, PS, and incidence of tax. S D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 28

Active Learning 2 P 140 Q = 80 130 PB = $110 120 PS = $80 Incidence buyers: $10 sellers: $20 PB = 110 100 90

Answers The market for hotel rooms S Tax PS = 80 D 70 60 50 40 0 Q 50 60 70 80 90 100 110 120 130 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 29 Elasticity and Tax Incidence CASE 1: Supply is more elastic than demand

P Buyers share of tax burden PB Tax Price if no tax Sellers share of tax burden Its easier for sellers than S buyers to leave the market. So buyers bear most of the burden of the tax. PS D Q 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 30

Elasticity and Tax Incidence CASE 2: Demand is more elastic than supply P Buyers share of tax burden PB Price if no tax Sellers share of tax burden S Tax PS Its easier for buyers than sellers to leave the market. Sellers bear most of the burden of the tax. D Q

2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 31 Who pays the luxury tax? 1990, Congress adopted a new luxury tax On yachts, private airplanes, furs, jewelry, expensive cars Goal: to raise revenue from those who could most easily afford to pay Luxury items Demand is quite elastic Supply is relatively inelastic 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 32 CASE STUDY: Who Pays the Luxury Tax? The market for yachts P

Buyers share of tax burden Demand is price-elastic. S In the short run, supply is inelastic. PB Tax Sellers share of tax burden PS D Q Hence, companies that build yachts pay most of the tax.

2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 33 Active Learning 3 The 2011 payroll tax cut Prior to 2011, the Social Security payroll tax was 6.2% taken from workers pay and 6.2% paid by employers (total 12.4%). The Tax Relief Act (2010) reduced the workers portion from 6.2% to 4.2% in 2011, but left the employers portion at 6.2%. Should this change have increased the typical workers take-home pay by exactly 2%, more than 2%, or less than 2%? Do any elasticities affect your answer? Explain. FOLLOW-UP QUESTION: Who gets the bigger share of this tax cut, workers or employers? How do elasticities determine the answer? 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 34

Active Learning 3 Answers As long as labor supply and labor demand both have price elasticity > 0, the tax cut will be shared by workers and employers, i.e., workers takehome pay will rise less than 2%. The answer does NOT depend on whether labor demand is more or less elastic than labor supply. FOLLOW-UP QUESTION : If labor demand is more elastic than labor supply, workers get more of the tax cut than employers. If labor demand is less elastic than labor supply, employers get the larger share of the tax cut. 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 35 Summary A price ceiling is a legal maximum on the price of a good. An example is rent control. If the price ceiling is below the equilibrium price, it is binding and causes a shortage. A price floor is a legal minimum on the price of

a good. An example is the minimum wage. If the price floor is above the equilibrium price, it is binding and causes a surplus. The labor surplus caused by the minimum wage is unemployment. 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 36 Summary A tax on a good places a wedge between the price buyers pay and the price sellers receive, and causes the equilibrium quantity to fall, whether the tax is imposed on buyers or sellers. The incidence of a tax is the division of the burden of the tax between buyers and sellers, and does not depend on whether the tax is imposed on buyers or sellers. The incidence of the tax depends on the price elasticities of supply and demand. 2018 Cengage Learning. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use. 37

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