Interactive Ch 06 Supply, Demand, and Government Policies-1

Supply, Demand, and Government Policies

• Supply: Refers to the quantity of a good or service that producers are willing to sell at various prices.

• Demand: Represents the quantity of a good or service that consumers are willing to purchase at different price levels.

• Government Policies: Include regulations, taxes, and subsidies that can influence market outcomes by affecting supply and demand dynamics. These policies can lead to market distortions, such as price ceilings or floors, which can create shortages or surpluses in the market.

Key Concepts

Price Controls

• Price Ceiling: A legal maximum price at which a good can be sold. This is often implemented by governments to protect consumers from excessively high prices.

  • Example: Rent-control laws, which aim to make housing affordable by limiting how much landlords can charge for rent. However, they can lead to reduced investment in the housing sector, exacerbating shortages.

• Price Floor: A legal minimum price at which a good can be sold. The purpose is to ensure that sellers receive a minimum reward for their efforts.

  • Example: Minimum wage laws that aim to ensure that workers earn a living wage, but can also lead to higher unemployment rates among unskilled workers if the minimum wage is set too high compared to the equilibrium wage.

Effects of Price Controls

• Price controls can lead to unintended consequences:

  • Alter Private Market Outcomes: Distortion of natural supply and demand can result in inefficient allocation of resources.

  • Lead to Shortages or Surpluses: Price ceilings may cause shortages (where demand exceeds supply) and price floors can lead to surpluses (where supply exceeds demand).

Taxation in Markets

• Purpose of Taxes: Taxes raise revenue for public projects such as roads, schools, and national defense, and help redistribute wealth within the economy.

• Tax Incidence: The distribution of the tax burden among market participants; it is influenced by the price elasticity of demand and supply.

  • If a tax is imposed on buyers, the demand curve shifts downwards, meaning buyers pay a lower effective price while sellers receive less. Conversely, if imposed on sellers, the supply curve shifts upward.

Examples of Market Outcomes

Market for Apartments

• Equilibrium without Price Controls:

  • Price: $800, Quantity: 300 units of rental apartments.

• Non-Binding Price Ceiling:

  • A price ceiling set at $1000, above the equilibrium price, leads to no effect on the market outcome; equilibrium remains at $800.

• Binding Price Ceiling:

  • If a price ceiling is set below the equilibrium price (e.g., $500), it creates a shortage as quantity demanded (400 units) exceeds quantity supplied (250 units).

• Long-Run Effects of Price Ceilings:

  • Over time, as supply and demand become more elastic, shortages may worsen; a price ceiling of $500 results in increased demand and reduced supply.

• Rationing Due to Shortages:

  • Sellers often resort to rationing, leading to unfair practices, inefficiency, and goods potentially going to those who do not value them most.

Market for Unskilled Labor

• Equilibrium without Price Controls:

  • Wage: $9.00, Quantity: 500 unskilled workers employed.

• Non-Binding Price Floor:

  • A price floor set below the equilibrium wage at $7.00 does not affect the market outcome, which remains unchanged at $9.00.

• Binding Price Floor:

  • A price floor set at $10.25 results in lower demand (400 jobs) compared to higher supply (550 individuals seeking jobs), leading to unemployment or a surplus in the labor market.

• Long-Run Effects of Minimum Wage:

  • Minimum wage laws especially affect the teenage labor market since they are often entry-level positions. A short-run increase of 10% in minimum wage could reduce teenage employment by 1-3%. The long-run effects are less predictable but may lead to higher unemployment rates amongst inexperienced workers.

Minimum Wage Debates

• Advocates' Position:

  • Proponents argue that minimum wage increases income for the working poor and contributes to poverty reduction strategies.

• Opponents' Position:

  • Critics claim that minimum wage leads to increased unemployment rates, especially among younger or less experienced workers, and may deter investment in education.

  • An important point of contention is that many minimum-wage earners do not come from families living in poverty, complicating the argument regarding the effectiveness of minimum wage laws as a poverty alleviation tool.

Examples of Price Controls on Bicycles

• Effect of Price Ceiling ($90):

  • Enforcing a price ceiling at $90 leads to a shortage of 30 bicycles, highlighting the impact of regulatory price limits on supply.

• Effect of Price Floor ($90):

  • The equilibrium remains unaffected since the floor is above the market equilibrium price.

• Binding Price Floor ($120):

  • A binding price floor rises to $120, creating a surplus of 60 bicycles, indicating producers are willing to supply more than consumers are willing to buy at this price.

Evaluating Price Controls

• Economists generally oppose price ceilings and floors due to their inefficiencies and adverse market impacts.

  • Alternative solutions—such as rent subsidies or wage subsidies—are often suggested to manage affordability without causing market distortions.

Taxes and Market Equilibrium

• The implementation of a $1.50 tax on buyers shifts the demand curve down by that amount, leading to a new equilibrium that reflects a reduced quantity from 500 to 450 units, as well as altered prices: buyers pay $11.00 and sellers receive $9.50.

Tax Incidence and Elasticity

• The burden of the tax on buyers and sellers is heavily influenced by the elasticity of demand and supply:

  • Elastic Supply and Inelastic Demand: Buyers tend to bear a larger burden.

  • Inelastic Supply and Elastic Demand: Sellers bear more of the burden.

Case Study: Luxury Tax

• The 1990 luxury tax on high-end goods raised significant concerns regarding the burden placed on consumers, highlighting the importance of understanding demand elasticity in evaluating tax impacts on different market segments and the overall economy.

Summary of Key Points

• Price ceilings typically lead to shortages, while price floors often create surpluses in the market.

• Taxation introduces a wedge between the price paid by buyers and the price received by sellers, with the distribution of this burden contingent on the relative elasticities of demand and supply.