Chapter 6: Supply, Demand, and Government Policies

Chapter 6 Supply, Demand, and Government Policies N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2 Controls on Prices, Part 1 • Price controls – Policymakers believe that the market price of a good or service is unfair to buyers or sellers – Can generate inequities • Taxes – To raise revenue for public purposes – To influence market outcomes N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 3 Controls on Prices, Part 2 • Price ceiling – A legal maximum on the price at which a good can be sold – Rent-control laws • Price floor – A legal minimum on the price at which a good can be sold – Minimum wage laws N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 4 Controls on Prices, Part 3 How price ceilings affect market outcomes – Not binding • Set above the equilibrium price • No effect on the price or quantity sold – Binding constraint • Set below the equilibrium price: Shortage • Sellers must ration the scarce goods • Rationing mechanisms: long lines, discrimination according to sellers bias N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 5 Figure 1 A Market with a Price Ceiling N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 6 Lines at the Gas Pump, Part 1 • 1973, OPEC raised the price of crude oil – Reduced the supply of gasoline – Long lines at gas stations • What was responsible for the long gas lines? – OPEC • Shortage of gasoline – U.S. government regulations • Price ceiling on gasoline N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 7 Lines at the Gas Pump, Part 2 • Price ceiling on gasoline – Before OPEC raised the price of crude oil • Equilibrium price was below the price ceiling • No effect on the market – When the price of crude oil rose • Decrease in the supply of gasoline • Equilibrium price was above the price ceiling • Binding price ceiling: Severe shortage • Laws regulating the price of gasoline were repealed N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 8 Figure 2 The Market for Gasoline with a Price Ceiling N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 9 ASK THE EXPERTS, Part 1 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.” N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 10 Rent Control in the Short Run and the Long Run, Part 1 • Price ceiling: rent control – Local government places a ceiling on rents – Goal: to help the poor • Making housing more affordable – Critique • Highly inefficient way to help the poor raise their standard of living N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 11 Rent Control in the Short Run and the Long Run, Part 2 • Adverse effects in the short run – Supply and demand for housing are inelastic in the short run – Small shortage – Reduced rents N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 12 Rent Control in the Short Run and the Long Run, Part 3 • Adverse effects in the long run – Supply and demand are more elastic – Landlords • Are not building new apartments • Are failing to maintain existing ones – People • Find their own apartments • Induce more people to move into a city – Large shortage of housing N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 13 Rent Control in the Short Run and the Long Run, Part 4 • Adverse effects in the long run – Rationing mechanisms • Long waiting lists • Preference to tenants without children • Discriminate on the basis of race • Bribes to building superintendents • People respond to incentives – Free markets • Landlords – clean and safe buildings • Higher prices N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 14 Rent Control in the Short Run and the Long Run, Part 5 • People respond to incentives – Rent control • Shortages and waiting lists • Landlords lose their incentive to respond to tenants’ concerns • Tenants get lower rents and lower-quality housing • Policymakers – additional regulations – Difficult and costly to enforce N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 15 Figure 3 Rent Control in Short Run and in Long Run N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 16 Controls on Prices, Part 4 How price floors affect market outcomes – Not binding • Set below the equilibrium price • No effect on the market – Binding constraint • Set above the equilibrium price: Surplus • Some sellers are unable to sell what they want • Rationing mechanisms: not desirable N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 17 Figure 4 A Market with a Price Floor N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 18 ASK THE EXPERTS, Part 2 The Minimum Wage “If the federal minimum wage is raised gradually to $15-per-hour by 2020, the employment rate for lowwage U.S. workers will be substantially lower than it would be under the status quo.” N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 19 The Minimum Wage, Part 1 • Price floor: minimum wage – Lowest price for labor that any employer may pay • Fair Labor Standards Act of 1938 – Ensures workers a minimally adequate standard of living • 2018, federal minimum wage, $7.25/hour – Some states mandate minimum wages above the federal level N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 20 The Minimum Wage, Part 2 • France – Average income is 30% lower than in the U.S. – Minimum wage is more than 30% higher • Market for labor – Workers supply labor – Firms demand labor N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 21 The Minimum Wage, Part 3 • If minimum wage is above equilibrium – Unemployment – Higher income for workers who have jobs – Lower income for workers who cannot find jobs • Impact of the minimum wage on highly skilled and experienced workers – No effect: their equilibrium wages are well above the minimum – Minimum wage: not binding N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 22 The Minimum Wage, Part 4 • Impact of the minimum wage on teenage labor – Least skilled and least experienced – Low equilibrium wages – Willing to accept a lower wage in exchange for on-the-job training – Minimum wage: binding N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 23 The Minimum Wage, Part 5 • Teenage labor market – A 10% increase in the minimum wage depresses teenage employment between 1 and 3% – Some teenagers who are still attending high school choose to drop out and take jobs • Displace other teenagers who had already dropped out of school and who now become unemployed N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 24 Figure 5 How Minimum Wage Affects Labor Market N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 25 The Minimum Wage, Part 6 • Advocates of the minimum wage – Raise the income of the working poor • Workers who earn the minimum wage can afford only a meager standard of living • Opponents of the minimum wage – Not the best way to combat poverty • Unemployment, encourages teenagers to drop out of school, prevents some unskilled workers from getting on-the-job training – Poorly targeted policy N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 26 Evaluating Price Controls, Part 1 • 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 N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 27 Evaluating Price Controls, Part 2 • 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) N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 28 Taxes, Part 1 • 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 N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 29 Taxes, Part 2 How taxes on sellers affect market outcomes – Immediate impact on sellers: shift in supply – Supply curve shifts left – Higher equilibrium price – Lower equilibrium quantity – The tax reduces the size of the market N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 30 Figure 6 A Tax on Sellers N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 31 Taxes, Part 3 How taxes on sellers affect market outcomes – Taxes discourage market activity – Buyers and sellers share the burden of tax – Buyers pay more, are worse off – Sellers receive less, are worse off • Get the higher price but pay the tax • Overall: effective price fall N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 32 Taxes, Part 4 How taxes on buyers affect market outcomes – Initial impact on the demand – Demand curve shifts left – Lower equilibrium price – Lower equilibrium quantity – The tax reduces the size of the market N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 33 Figure 7 A Tax on Buyers N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 34 Taxes, Part 5 How taxes on buyers affect market outcomes – Buyers and sellers share the burden of tax – Sellers get a lower price, are worse off – Buyers pay a lower market price, are worse off • Effective price (with tax) rises N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 35 Taxes, Part 6 Taxes levied on sellers and taxes levied on buyers are equivalent – Wedge between the price that buyers pay and the price that sellers receive • The same, regardless of whether the tax is levied on buyers or sellers – Shifts the relative position of the supply and demand curves • Buyers and sellers share the tax burden N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 36 Can Congress Distribute the Burden of a Payroll Tax?, Part 1 • Payroll taxes – Deducted from the amount you earned • By law, the tax burden: – Half of the tax is paid by firms • Out of firm’s revenue – Half of the tax is paid by workers • Deducted from workers’ paychecks N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 37 Can Congress Distribute the Burden of a Payroll Tax?, Part 2 • Tax incidence analysis – Payroll tax as a tax on a good • The good is labor • The price is the wage • Introduce payroll tax – Wage received by workers falls – Wage paid by firms rises – Workers and firms share the tax burden • Not necessarily 50 – 50 as required N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 38 Can Congress Distribute the Burden of a Payroll Tax?, Part 3 • Lawmakers – Can decide whether a tax comes from the buyer’s pocket or from the seller’s – Cannot legislate the true burden of a tax • Tax incidence – Determined by the forces of supply and demand N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 39 Figure 8 A Payroll Tax N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 40 Taxes, Part 7 • Elasticity and tax incidence – Very elastic supply and relatively inelastic demand • Sellers bear a small burden of tax • Buyers bear most of the burden – Relatively inelastic supply and very elastic demand • Sellers bear most of the tax burden • Buyers bear a small burden N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 41 Figure 9 How the Burden of a Tax Is Divided, Part 1 N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 42 Figure 9 How the Burden of a Tax Is Divided, Part 2 N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 43 Taxes, Part 8 • Tax burden – Falls more heavily on the side of the market that is less elastic – Small elasticity of demand • Buyers do not have good alternatives to consuming this good – Small elasticity of supply • Sellers do not have good alternatives to producing this good N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 44 Who Pays the Luxury Tax?, Part 1 • 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 N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 45 Who Pays the Luxury Tax?, Part 2 • Outcome: – Burden of a tax falls largely on the suppliers • Relatively inelastic supply • 1993: most of the luxury tax was repealed “If this boat were any more expensive, we’d be playing golf.” N. Gregory Mankiw, Principles Of Micro Economics, 9th Edition © 2021 Cengage. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 46