class: center, middle, inverse, title-slide .title[ # Supply, Demand and Government Policies ] .subtitle[ ## Chapter 6 ] .author[ ### Hussain Hadah ] .date[ ### University of Houston | 18 July 2022 ] --- <style type="text/css"> # CSS for including pauses in printed PDF output (see bottom of lecture) @media print { .has-continuation { display: block !important; } } </style> # Table of contents 1. [Introduction](#intro) 2. [Controls on Prices](#sec1) 3. [Taxes](#sec2) 4. [Problems and Applications](#sec3) --- class: inverse, center, middle name: intro # Introduction <html><div style='float:left'></div><hr color='#EB811B' size=1px width=796px></html> --- # Does government matter? ### The government can intervene in all types of markets ### Economists study and analyze the effects of these policies ### Examples of government policies are rent controls, minimum wage, taxes, etc. --- class: inverse, center, middle name: sec1 # Controls on Prices <html><div style='float:left'></div><hr color='#EB811B' size=1px width=796px></html> --- # How price controls affect markets - In a free market, prices and quantities clear at the equilibrium - Prices adjust to balance supply and demand -- - Let's consider the ice cream example from the last lecture - The price of ice cream at equilibrium is $3 per cone - Buyers might find the $3 to be a high price and pressure the government to control the price of ice cream - Sellers might find the to be a low price and pressure the government to control the price of ice cream -- - <span style="color:red;"> _Price ceiling_</span> is a legislated maximum in which the price of a good cannot rise above - <span style="color:red;"> _Price floor_</span> is a legislated minimum in which the price of a good cannot fall below --- # Price ceilings and the market <img src="images/image1.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- # The gasoline market <img src="images/image2.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- # Rent control <img src="images/image3.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- # Price floors and markets <img src="images/image4.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- # Minimum wage <img src="images/image5.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- class: inverse, center, middle name: sec2 # Taxes <html><div style='float:left'></div><hr color='#EB811B' size=1px width=796px></html> --- # What is a tax? - All governments use taxes to raise revenue #### We need to address important questions to analyze a tax When the government imposes a tax on a good #### Who bears the burden of the tax, buyers or sellers? #### If buyers and sellers share the tax burden, what determines how the burden is divided? #### Can the government legislate how the burden is divided or is the division determined by the market forces? #### <span style="color:red;"> _Tax incidence_</span> refers to how the burden of a tax is distributed --- <h1 style="font-size:32px"> How do taxes on sellers affect market outcomes?</h1> </br> - Suppose a tax of $0.5 per ice cream cone is levied on ice cream sellers - To analyze how this law would affect the buyers and sellers of ice cream, we need to follow the following steps: 1. We decide whether the law affects the supply curve or the demand curve 2. We decide which way the curve shifts 3. We examine how the shift affects the equilibrium price and quantity --- # Step one ## A tax on sellers would affect the supply curve ## A tax on buyers would affect the demand curve --- # Step two ## A tax on sellers would affect the supply curve `\(\Rightarrow\)` supply would shift to the left ## A tax on buyers would affect the demand curve `\(\Rightarrow\)` demand curve shifts downward --- # Step three ## After determining whether the demand or supply was affected (step 1) and in which direction are they going to shift (step 2), we will be able to analyze the new equilibrium --- # A tax on sellers <img src="images/image6.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- # Tax implications ## Who pays the tax? -- <h3> <ul> -- <li>To answer the question we should go back to tax incidence</li> -- <li>In the previous graph, buyers are paying $0.3 more and sellers get to keep $2.8</li> -- <li>The tax in the previous case makes the buyers and sellers worse off</li> -- <li>Taxes discourage market activity</li> -- <li>Buyers and sellers share the burden of taxes</li> </ul> </h3> --- # Effect of taxes on buyers - The government imposes a $0.5 per cone tax on ice cream - This tax affects demand and shifts it downward <img src="images/image7.png" width="70%" height="70%" style="display: block; margin: auto;" /> --- # Elasticity and tax incidence <img src="images/image8.png" width="70%" height="70%" style="display: block; margin: auto;" /> --- # Gas Tax Holiday <img src="images/nyt.png" width="100%" height="100%" style="display: block; margin: auto;" /><img src="images/wh.png" width="100%" height="100%" style="display: block; margin: auto;" /> --- class: inverse, center, middle name: sec3 # Problems and Applications <html><div style='float:left'></div><hr color='#EB811B' size=1px width=796px></html> --- # Question 1 ### Lovers of Taylor Swift music persuade Congress to impose a price ceiling of $40 per concert ticket. As a result of this policy, do more or fewer people attend Taylor Swift concerts? Explain. -- #### If $40 is less than the equilibrium price, then Taylor Swift will sell less ticket -- #### If $40 is less than the equilibrium price, then Taylor Swift fans will demand more tickets -- #### Quanitity demanded > Quantity supplied `\(\Rightarrow\)` there will be a shortage and less people will attend -- <img src="https://media.giphy.com/media/VDIqlLXSWas36/giphy.gif" width="30%" height="30%" style="display: block; margin: auto;" /> --- # Question 2 #### The government has decided that the free-market price of cheese is too low. -- #### a. Suppose the government imposes a binding price floor in the cheese market. Draw a supply-and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese? -- <img src="images/ques2a.png" width="40%" height="40%" style="display: block; margin: auto;" /> --- # Question 2 #### The government has decided that the free-market price of cheese is too low. -- #### b. Producers of cheese complain that the price floor has reduced their total revenue. Is this possible? Explain. -- <h5> <ul> <li>If demand is elastic, then the producers’ complaint correct</li> <li>With elastic demand, quantity demand will respond substantially in reponse to a price change</li> </ul> </h5> -- #### c. In response to cheese producers’ complaints, the government agrees to purchase all the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses? -- <h5> <ul> <li>Producers win, taxpayers lose</li> <li>Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially</li> <li>consumers would buy only quantity Q2 of cheese, so they are in the same position as before</li> <li>Taxpayers lose because they would be financing the purchase of the surplus cheese through higher taxes</li> </ul> </h5> -- <img src="https://media.giphy.com/media/xUPGct8TH5B0Z70HBe/giphy.gif" width="20%" height="20%" style="display: block; margin: auto;" /> --- # Question 3 #### A recent study found that the demand-and-supply schedules for Frisbees are as follows: <img src="images/ques3.png" width="50%" height="50%" style="display: block; margin: auto;" /> -- ##### a. What are the equilibrium price and quantity of Frisbees? -- ##### `\(P = 8\)` and `\(Q = 6,000,000\)` -- ##### b. Frisbee manufacturers persuade the government that Frisbee production improves scientists’ understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees are sold? -- ##### The price floor of $10 is binding, thus, new equilibrium price is $10 and only two million Frisbees are sold, because that is the quantity demanded --- # Question 3 #### A recent study found that the demand-and-supply schedules for Frisbees are as follows: <img src="images/ques3.png" width="50%" height="50%" style="display: block; margin: auto;" /> -- ##### c. Irate college students called their reps to demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former price floor. What is the new market price? How many Frisbees are sold? -- ##### `\(P = 9\)` which has no effect on the market since `\(P^{*} = 8\)`. So `\(P = 8\)` and `\(Q = 6,000,000\)` --- # Question 4 ##### Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. (In fact, both the federal and state governments impose beer taxes of some sort.) ##### a. Draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? -- <img src="images/ques4a.png" width="40%" height="40%" style="display: block; margin: auto;" /> --- # Question 4 ##### Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. (In fact, both the federal and state governments impose beer taxes of some sort.) ##### b. Now draw a supply-and-demand diagram for the beer market with the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? Has the quantity of beer sold increased or decreased? -- <img src="images/ques4b.png" width="40%" height="40%" style="display: block; margin: auto;" /> --- # Question 5 #### A senator wants to raise tax revenue and make workers better off. A staff member proposes raising the payroll tax paid by firms and using part of the extra revenue to reduce the payroll tax paid by workers. Would this accomplish the senator’s goal? Explain. -- <h4> <ul> <li>Raising the payroll tax paid by firms and using part of the extra revenue to reduce the payroll tax paid by workers would not make workers better off</li> <li>Division of the burden of a tax depends on the elasticity of supply and demand and not on who must pay the tax</li> <li>Because the tax wedge would be larger, it is likely that both firms and workers, who share the burden of any tax, would be worse off</li> </ul> </h4> --- # Question 6 #### If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than $500, less than $500, or exactly $500? Explain. -- <h4> <ul> <li>The price will rise by less than $500</li> <li>The burden of any tax is shared by both producers and consumersthe price paid by consumers rises and the price received by producers falls, with the difference between the two equal to the amount of the tax</li> <li>The only exceptions would be if the supply curve were perfectly elastic or the demand curve were perfectly inelastic, in which case consumers would bear the full burden of the tax and the price paid by consumers would rise by exactly $500</li> </ul> </h4> --- # Question 7 ### Congress and the president decide that the United States should reduce air pollution by reducing its use of gasoline. They impose a $0.50 tax on each gallon of gasoline sold. -- #### a. Should they impose this tax on producers or consumers? Explain carefully using a supply-and-demand diagram. -- <img src="images/ques7a.png" width="40%" height="40%" style="display: block; margin: auto;" /> --- # Question 7 ### Congress and the president decide that the United States should reduce air pollution by reducing its use of gasoline. They impose a $0.50 tax on each gallon of gasoline sold. -- #### b. If the demand for gasoline were more elastic, would this tax be more effective or less effective in reducing the quantity of gasoline consumed? Explain with both words and a diagram. -- <img src="images/ques7b.png" width="40%" height="40%" style="display: block; margin: auto;" /> --- # Question 7 ### Congress and the president decide that the United States should reduce air pollution by reducing its use of gasoline. They impose a $0.50 tax on each gallon of gasoline sold. -- #### c. Are consumers of gasoline helped or hurt by this tax? Why? -- #### The consumers of gasoline are hurt by the tax because they get less gasoline at a higher price. -- #### d. Are workers in the oil industry helped or hurt by this tax? Why? -- #### Workers in the oil industry are hurt by the tax as well. With a lower quantity of gasoline being produced, some workers may lose their jobs. With a lower price received by producers, wages of workers might decline. --- # Question 8 ### A case study in this chapter discusses the federal minimum-wage law. -- #### a. Suppose the minimum wage is above the equilibrium wage in the market for unskilled labor. Using a supply-and-demand diagram of the market for unskilled labor, show the market wage, the number of workers who are employed, and the number of workers who are unemployed. Also show the total wage payments to unskilled workers. -- <img src="images/ques8a.png" width="40%" height="40%" style="display: block; margin: auto;" /> --- # Question 8 ### A case study in this chapter discusses the federal minimum-wage law. -- #### b. Now suppose the secretary of labor proposes an increase in the minimum wage. What effect would this increase have on employment? Does the change in employment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither? -- ##### An increase in the minimum wage would decrease employment. The size of the effect on employment depends only on the elasticity of demand. The elasticity of supply does not matter, because there is a surplus of labor. -- #### c. What effect would this increase in the minimum wage have on unemployment? Does the change in unemployment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither? -- ##### The increase in the minimum wage would increase unemployment. The size of the rise in unemployment depends on both the elasticities of supply and demand. The elasticity of demand determines the change in the quantity of labor demanded, the elasticity of supply determines the change in the quantity of labor supplied, and the difference between the quantities supplied and demanded of labor is the amount of unemployment. --- # Question 8 ### A case study in this chapter discusses the federal minimum-wage law. -- #### d. If the demand for unskilled labor were inelastic, would the proposed increase in the minimum wage raise or lower total wage payments to unskilled workers? Would your answer change if the demand for unskilled labor were elastic? -- #### If the demand for unskilled labor were inelastic, the rise in the minimum wage would increase total wage payments to unskilled labor. With inelastic demand, the percentage decline in employment would be lower than the percentage increase in the wage, so total wage payments increase. However, if the demand for unskilled labor were elastic, total wage payments would decline, because then the percentage decline in employment would exceed the percentage increase in the wage.