Chapter 6
Supply, Demand, and Government Policies
Economists have two roles. As scientists, they develop and test theories to explain the world around them. As policy advisers, they use their theories to help change the world for the better.
Policies often have effects that their architects did not intend or anticipate.
Supply, Demand, and Government Policies
In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
One of the roles of economists is to use their theories to assist in the development of policies.
CONTROLS ON PRICES
Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
Result in government-created price ceilings and floors.
Price Ceiling
A legal maximum on the price at which a good can be sold.
Price Floor
A legal minimum on the price at which a good can be sold.
How Price Ceilings Affect Market Outcomes
Two outcomes are possible when the government imposes a price ceiling:
The price ceiling is not binding if set above the equilibrium price.
The price ceiling is binding if set below the equilibrium price, leading to a shortage.
(a) A Price Ceiling That Is Not Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Equilibrium
quantity
$4
Price
ceiling
Equilibrium
price
Demand
Supply
3
100
Figure 6-1. A Market with a Price Ceiling
Copyright©2003 Southwestern/Thomson Learning
(b) A Price Ceiling That Is Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Demand
Supply
2
Price
ceiling
Shortage
75
Quantity
supplied
125
Quantity
demanded
Equilibrium
price
$3
Figure 6-1. A Market with a Price Ceiling
Figure 6-1. A Market With A Price Ceiling.
In panel (a), the government imposes a price ceiling of $4. Because the price ceiling is above the equilibrium price of $3, the price ceiling has no effect, and the market can reach the equilibrium of supply and demand. In this equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price ceiling of $2, the market price equals $2, 125 cones are demanded and only 75 are supplied, so there is a shortage of 50 cones. (Mankiw,)
Quantity of
Ice-Cream
Cones
100
0
3
$4
(a) A Price Ceiling That Is Not Binding
Price of
Ice-Cream
Cone
Equilibrium
price
Equilibrium
quantity
Price
ceiling
Supply
Demand
Equilibrium
price
Quantity of
Ice-Cream
Cones
75
0
2
$3
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Quantity
supplied
Price ceiling
Supply
Demand
Quantity
demanded
125
Shortage
How Price Ceilings Affect Market Outcomes
Effects of Price Ceilings
A binding price ceiling creates
shortages because QD > QS.
Example: Gasoline shortage of the 1970s
nonprice rationing
Examples:Long lines, discrimination by sellers.
Case Study: Lines at the Gas Pump
In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline.
What was responsible for the long gas lines? Most people blame OPEC. Surely, if OPEC had not raised the price of crude oil, the shortage of gasoline would not have occurred.
Yet economists blame government regulations that limited the price oil companies could charge for gasoline. (Mankiw, Principles of Economics(2004), third edition, p116.)
Figure 6-2 shows what happened.
Copyright©2003 Southwestern/Thomson Learning
(a) The Price Ceiling on Gasoline Is Not Binding
Quantity of
Gasoline
0
Price of
Gasoline
1. Initially,
the price
ceiling
is not
binding . . .
Price ceiling
Demand
Supply,
S1
P1
Q1
Fig 6-2. The Market for Gasoline with a Price Ceiling
Copyright©2003 Southwestern/Thomson Learning
(b) The Price Ceiling on Gasoline Is Binding
Quantity of
Gasoline
0
Price of
Gasoline
Demand
S1
S2
Price ceiling
QS
4. . . .
resulting
in a
shortage.
3. . . . the price
ceiling becomes
binding . . .
2. . . . but when
supply falls . . .
P2
QD
P1
Q1
Fig 6-2. The Market for Gasoline with a Price Ceiling
Figure 6-2. The Market For Gasoline With A Price Ceiling.
Panel (a) shows the gasoline market when the price ceiling is not binding because the equilibrium price P1, is below the ceiling. Panel (b) shows the gasoline market after an increase in the price of crude oil (an input into making gasoline) shifts the supply curve to the left from S1 to S2. In an unregulated market, the price would have risen from P1 to P2. The price ceiling, however, prevents this from happening. At the binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS. The difference between quantity demand and quantity supplied, QD - QS, measures the gasoline shortage.
Quantity of
Gasoline
Q1
0
P1
(a) The Price Ceiling on Gasoline Is Not Binding
Price of
Gasoline
1. Initially the price
ceiling is not binding…
Price ceiling
Supply, S1
Demand
Quantity of
Gasoline
Q1
0
P1
(b) The Price Ceiling on Gasoline Is Binding
Price of
Gasoline
4. …resulting
in a shortage
Price ceiling
S1
Demand
P2
QD
QS
2. …but when
supply falls …
3. …the price
ceiling becomes
binding…
S2
CASE STUDY: Rent Control in the Short Run and Long Run
In many cities, the local government places a ceiling on rents that landlords may charge their tenants.
The goal of rent control policy is to help the poor by making housing more affordable.
Economists often criticize rent control, arguing that it is a highly inefficient way to help the poor raise their standard of living. One economist called rent control “the best way to destroy a city, other than bombing.”
Rent Control in the Short Run and Long Run
The adverse effects of rent controls are less apparent to the general population because these effects occur over many years. In the short run, landlords have a fixed number of apartments to rent, and they cannot adjust this number quickly as market conditions change. Moreover, the number of people searching for housing in a city may not be highly responsive to rents in the short run because people take time to adjust their housing arrangements. Therefore, the short-run supply and demand for housing are relatively inelastic.
Rent Control in the Short Run and Long Run
The long run story is very different because the buyers and sellers of rental housing respond more to market conditions as time passes. On the supply side, landlords respond to low rents by not building new apartments and by failing to maintain existing ones. On the demand side, low rents encourage people to find their own apartments(rather than living with their parents or sharing apartments with roommates) and induce more people to move into a city. Therefore, both supply and demand are more elastic in the long-run .
Rent Control in the Short Run and Long Run
In cities with rent control, landlords use various mechanisms to ration housing. Some landlords keep long waiting lists. Others give a preference to tenants without children. Still others discriminate on the basis of race. Sometimes, apartments are allocated to those willing to offer under-the-table payments to building superintendents. In essence, these bribes bring the total price of an apartment(including the bribe) closer to the equilibrium price.
Rent Control in the Short Run and Long Run
To understand fully the effects of rent control, we have to remember “People respond to incentives.” In free markets, landlords try to keep their buildings clean and safe because desirable apartments command higher prices.
By contrast, when rent control creates shortages and waiting lists, landlords lose their incentive to respond to tenants’ concerns.
In the end, tenants get lower rents, but they also get lower-quality housing.(Mankiw, Principles of Economics, third edition, p118.)
Figure 3 Rent Control in the Short Run and in the Long Run
Copyright©2003 Southwestern/Thomson Learning
(a) Rent Control in the Short Run
(supply and demand are inelastic)
Quantity of
Apartments
0
Supply
Controlled rent
Rental
Price of
Apartment
Demand
Shortage
Figure 3 Rent Control in the Short Run and in the Long Run
Copyright©2003 Southwestern/Thomson Learning
(b) Rent Control in the Long Run
(supply and demand are elastic)
0
Rental
Price of
Apartment
Quantity of
Apartments
Demand
Supply
Controlled rent
Shortage
Figure 6-3. Rent Control In The Short Run And In The Long Run.
Panel (a) shows the short-run effects of rent control: Because the supply and demand for apartments are relatively inelastic, the price ceiling imposed by a rent-control law causes only a small shortage of housing. Panel (b) shows the long-run effects of rent control: Because the supply and demand for apartments are more elastic, rent control causes a large shortage.
Quantity of
Apartments
0
(a) Rent Control in the Short Run
(supply and demand are inelastic)
Rental
Price of
Apartment
Controlled rent
Supply
Demand
Shortage
Quantity of
Apartments
0
(b) Rent Control in the Long Run
(supply and demand are elastic)
Rental
Price of
Apartment
Controlled rent
Supply
Demand
Shortage
Appendix Fig6-4. Price Controls Produce Shortages
Without a legal price ceiling, price would rise to E. At the ceiling price of $1, supply and demand do not balance, and shortages break out. Some method of rationing, formal or informal, is needed to allocate the short supply and bring the actual demand down to D'D'.(Samuelson, Economics,17th, P81)
P
QS
$1
O
D
S
E
D'
K
Quantity (billion of gallons)
Price
Q
$2
$3
S
J
C
Ceiling price
Equilibrium level
Without price ceiling
Deficiency of supply
at ceiling price
QD
Q*
Shortage
How Price Floors Affect Market Outcomes
When the government imposes a price floor, two outcomes are possible.
The price floor is not binding if set below the equilibrium price.
The price floor is binding if set above the equilibrium price, leading to a surplus.
Figure 4 A Market with a Price Floor
Copyright©2003 Southwestern/Thomson Learning
(a) A Price Floor That Is Not Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Equilibrium
quantity
2
Price
floor
Equilibrium
price
Demand
Supply
$3
100
Figure 4 A Market with a Price Floor
Copyright©2003 Southwestern/Thomson Learning
(b) A Price Floor That Is Binding
Quantity of
Ice-Cream
Cones
0
Price of
Ice-Cream
Cone
Demand
Supply
$4
Price
floor
80
Quantity
demanded
120
Quantity
supplied
Equilibrium
price
Surplus
3
Figure 6-4. A Market With A Price Floor.
In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3. Therefore, the market price equals $4. Because 120cones are supplied at this price and only 80are demanded , there is a surplus of 40 cones.
Quantity of
Ice-Cream
Cones
0
2
$3
(a) A Price Floor Is Not Binding
Price of
Ice-Cream
Cone
Equilibrium
price
Price
floor
Supply
Demand
Equilibrium
quantity
100
(b) A Price Floor That Is Binding
Quantity of
Ice-Cream
Cones
80
0
3
$4
Price of
Ice-Cream
Cone
Equilibrium
price
Quantity
demanded
Price
floor
Supply
Demand
Surplus
Quantity
supplied
120
A price floor prevents supply and demand from moving toward the equilibrium price and quantity.
When the market price hits the floor, it can fall no further, and the market price equals the floor price.
How Price Floors Affect Market Outcomes
A binding price floor causes . . .
a surplus because QS > QD.
nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria.
Examples: The minimum wage, agricultural price supports.
The Minimum Wage: An important example of a price floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.
How Price Floors Affect Market Outcomes
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Labor
Wage
0
Labor
demand
Labor
Supply
Equilibrium
employment
Equilibrium
wage
Figure 6-5. How the Minimum Wage Affects the Labor Market
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Labor
Wage
0
Labor
Supply
Labor surplus
(unemployment)
Labor
demand
Minimum
wage
Quantity
demanded
Quantity
supplied
Figure 6-5. How the Minimum Wage Affects the Labor Market
Figure 6-5. How The Minimum Wage Affects The Labor Market.
Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus. The quantity of labor supplied exceeds the quantity demanded. The result is unemployment.
Quantity of
Labor
0
(a) A Free Labor Market
Wage
Equilibrium
wage
Labor
supply
Labor
demand
Equilibrium
employment
Quantity of
Labor
0
(b) A Labor Market with a
Binding Minimum Wage
Wage
Minimum
wage
Labor
supply
Labor
demand
Quantity
demanded
Quantity
supplied
Labor surplus
(unemployment)
M
N
E
An important example of a price floor is the minimum wage. Minimum-wage laws dictate the lowest price for labor that any employer may pay. The . Congress first instituted a minimum wage with the Fair Labor Standards Act of 1938 to ensure workers a minimally adequate standard of living. In 2002 the minimum wage according to federal law was $ per hour, and some state laws imposed higher minimum wages. (Mankiw, Principles of Economics(2004), third edition, p121.)
Case Study: The Minimum Wage
To fully understand the minimum wage, keep in mind that the economy contains not a single labor market, but many labor markets for different types of workers. The impact of the minimum wage depends on the skill and experience of the worker. Workers with high skills and much experience are not affected, because their equilibrium wages are well above the minimum. For these workers, the minimum wage is not binding. (Mankiw, p122.)
Case Study: The Minimum Wage
The minimum wage has its greatest impact on the market for teenage labor. The equilibrium wages of teenagers are low because teenagers are among the least skilled and least experienced members of the labor force. In addition, teenagers are often willing to accept a lower wage in exchange for on the job training. (Some teenagers are willing to work as “interns” for no pay at all. Because internships pay nothing, however, the minimum wage does not apply to them. If it did, these jobs might not exist.) As a result, the minimum wage is more often binding for teenagers than for other members of the labor force. (Mankiw, p122.)
Case Study: The Minimum Wage
The minimum wage is a frequent topic of political debate. Advocates of the minimum wage view the policy as one way to raise the income of the working poor. They correctly point out that workers who earn the minimum wage can afford only a meager standard of living. In 2002, for instance, when the minimum wage was $ per hour, two adults working 40 hours a week for every week of the year at minimum-wage jobs had a total annual income of only $21,424, which was less than half of the median family income. Many advocates of the minimum wage admit that it has some adverse effects, including unemployment, but they believe that these effects are small and that, all things considered, a higher minimum wage makes the poor better off.
Opponents of the minimum wage contend that it is not the best way to combat poverty. They note that a high minimum wage causes unemployment, encourages teenagers to drop out of school, and prevents some unskilled workers from getting the on-the-job training they need. Moreover, opponents of the minimum wage point out that the minimum wage is a poorly targeted policy. Not all minimum-wage workers are heads of households trying to help their families escape poverty. In fact, fewer than a third of minimum-wage earners are in families with incomes below the poverty line. Many are teenagers from middle-class homes working at part-time jobs for extra spending money.(Mankiw, p123.)
Case Study: The Minimum Wage
D
Wmarket
O
D
S
M
E
. Effects of a Minimum Wage
Q
Wmin
50
100
150
S
Unemployment
L
N
Unskilled labor
Wage
. Effects of a Minimum Wage
Setting the minimum-wage floor at Wmin, high above the free-market equilibrium rate at Wmarket, results in forced equilibrium at E. Employment is reduced, as the arrows show, from M to E. Additionally, unemployment is EL, which is the difference between labor supplied at L and employment at E. If the demand curve is inelastic, increasing the minimum wage will increase the income of low-wage workers.
(Samuelson, Economics,17th, P80)
Evaluating Price Controls
Yet price controls often hurt those they are trying to help. Rent control may keep rents low, but it also discourages landlords from maintaining their buildings and makes housing hard to find. Minimum-wages laws may raise the incomes of some workers, but they also cause other workers to be unemployed.
(Source: Mankiw, Principles of Economics(2004), third edition, P123.)
Evaluating Price Controls
Helping those in need can be accomplished in ways other than controlling prices. For instance, the government can make housing more affordable by paying a fraction of the rent for poor families. Unlike rent control, such rent subsidies do not reduce the quantity of housing supplied and, therefore, do not lead to housing shortages. Similarly, wage subsidies raise the living standards of the working poor without discouraging firms from hiring them. An example of a wage subsidy is the earned income tax credit, a government program that supplements the incomes of low-wage workers.
Although these alternative policies are often better than price controls, they are not perfect. Rent and wage subsidies cost the government money and, therefore, require higher taxes.
TAXES
Governments levy taxes to raise revenue for public projects.
How Taxes on Buyers (and Sellers) Affect Market Outcomes
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden.
Elasticity and Tax Incidence
Tax incidence is the manner in which the burden of a tax is shared among participants in a market.
Tax incidence is the study of who bears the burden of a tax.
Taxes result in a change in market equilibrium.
Buyers pay more and sellers receive less, regardless of whom the tax is levied on.
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Ice-Cream Cones
0
Price of
Ice-Cream
Cone
Price
without
tax
Price
sellers
receive
Equilibrium without tax
Tax ($)
Price
buyers
pay
D1
D2
Supply,
S1
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($).
$
90
Equilibrium
with tax
100
Figure 6-6. A Tax on Buyers
Figure 6-6. A Tax On Buyers.
When a tax of $ is levied on buyers, the demand curve shifts down by $ from D1 to D2. The equilibrium quantity falls from 100 to 90 cones. The price that buyers pay (including the tax) rises from $ to $. Even though the tax is levied on buyers, buyers and sellers share the burden of the tax.
Quantity of
Ice-Cream Cones
0
Equilibrium without tax
Price of
Ice-Cream
Cone
$
Supply,S1
D1
90
100
Tax ($)
Equilibrium
with tax
D2
A tax on buyers shifts the
demand curve downward
by the size of the tax ($).
Price sellers receive
Price without
tax
Price buyers pay
Elasticity and Tax Incidence
To sum up, the analysis yields two lessons:
What was the impact of tax?
Taxes discourage market activity. When a good is taxed, the quantity sold is smaller in the new equilibrium.
Buyers and sellers share the burden of taxes. In the new equilibrium, buyers pay more for the good, and sellers receive less.
Copyright©2003 Southwestern/Thomson Learning
Quantity of
Ice-Cream Cones
0
Price of
Ice-Cream
Cone
Price
without
tax
Price
sellers
receive
Equilibrium
with tax
Equilibrium without tax
Tax ($)
Price
buyers
pay
S1
S2
Demand,
D1
A tax on sellers
shifts the supply
curve upward
by the amount of
the tax ($).
100
$
90
Figure 6-7. A Tax on Sellers
Figure 6-7. A Tax On Sellers.
When a tax of $ is levied on sellers, the supply curve shifts up by $ from S1 to S2. The equilibrium quantity falls from 100 to 90 cones. The price that sellers pay rises from $ to $. Even though the tax is levied on sellers, buyers and sellers share the burden of the tax.
Quantity of
Ice-Cream Cones
0
Equilibrium without tax
Price of
Ice-Cream
Cone
$
Supply,S1
S2
90
100
Tax ($)
Equilibrium
with tax
S1
A tax on sellers shifts the
supply curve upward
by the amount of the
tax ($).
Price sellers receive
Price without
tax
Price buyers pay
Case study: Can Congress distribute the burden of a payroll tax?
In 2002, the total FICA(the Federal Insurance Contribution Act 联邦保险税法案) tax for the typical worker was percent of earnings.
Who do you think bears the burden of this payroll tax----firms or workers? When Congress passed this legislation, it tried to mandate a division of the tax burden. According to the law, half of the tax is paid by firms, an half is paid by workers. That is , half of the tax is paid out of firm revenue, and half is deducted from workers’ paychecks. The amount that shows up as a deduction on your pay stub存根,票根 is the worker contribution.
Copyright©2003 Southwestern/Thomson Learning
Quantity
of Labor
0
Wage
Labor demand
Labor supply
Tax wedge
Wage workers
receive
Wage firms pay
Wage without tax
Figure 6-8. A Payroll Tax
Figure 6-8. A Payroll Tax.
A payroll tax places a wedge between the wage that workers receive and the wage that firms pay. Comparing wages with and without the tax, you can see that workers and firms share the tax burden. This division of the tax burden between workers and firms does not depend on whether the government levies the tax on workers, levies the tax on firms, or divides the tax equally between the two groups.
Quantity of Labor
0
Wage
Labor demand
Tax wedge
Labor supply
Wage workers receive
Wage without tax
Wage firms pay
Our analysis of tax incidence, however, shows that lawmakers cannot so easily dictate the distribution of a tax burden. The key feature of the payroll tax is that it places a wedge between the wage that firms pay and the wage that workers receive. Figure 8 shows the outcome. When a payroll tax is enacted, the wage received by workers falls, and the wage paid by firms rises. In the end, workers and firms share the burden of the tax, much as the legislation requires. Yet this division of the tax burden between workers and firms has nothing to do with the legislated division: The division of the burden in figure 8 is not necessarily fifty-fifty, and the same outcome would prevail if the law levied the entire tax on workers or if it levied the entire tax on firms.
Case study: Can Congress distribute the burden of a payroll tax?
This example shows that the most basic lesson of tax incidence is often overlooked没注意到 in public debate. Lawmakers can decide whether a tax comes from the buyer’s pocket or from the seller’s, but they cannot legislate the true burden of a tax. Rather, tax incidence depends on the forces of supply and demand. (Mankiw, Principles of Economics(2004), third edition, p128.)
Elasticity and Tax Incidence
In what proportions is the burden of the tax divided?
How do the effects of taxes on sellers compare to those levied on buyers?
The answers to these questions depend on the elasticity of demand and the elasticity of supply.
Copyright©2003 Southwestern/Thomson Learning
Quantity
0
Price
Demand
Supply
Tax
Price sellers
receive
Price buyers pay
(a) Elastic Supply, Inelastic Demand
2. . . . the
incidence of the
tax falls more
heavily on
consumers . . .
1. When supply is more elastic
than demand . . .
Price without tax
3. . . . than
on producers.
Figure 6-9 How the Burden of a Tax Is Divided
Copyright©2003 Southwestern/Thomson Learning
Quantity
0
Price
Demand
Supply
Tax
Price sellers
receive
Price buyers pay
(b) Inelastic Supply, Elastic Demand
3. . . . than on
consumers.
1. When demand is more elastic
than supply . . .
Price without tax
2. . . . the
incidence of
the tax falls
more heavily
on producers . . .
Figure 6-9 How the Burden of a Tax Is Divided
Figure 6-9. How The Burden Of A Tax Is Divided..
In panel (a), the supply curve is elastic, and the demand curve is inelastic. In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially. Thus, buyers bear most of the burden of the tax. In panel (b), the supply curve is inelastic, and the demand curve is elastic. In this case, the price received by sellers falls substantially, while the price paid by buyers rises only slightly. Thus, sellers bear most of the burden of the tax.
2. …the incidence of the tax falls more heavily on consumers...
Quantity
0
Wage
Demand
Tax
Supply
Price sellers
receive
Wage
Without tax
Price
buyers pay
1. When supply is more elastic than demand…
3. …than on producers.
(a) Elastic Supply, Inelastic Demand
Quantity
0
Wage
Demand
Tax
Supply
Price sellers
receive
Wage without
tax
Price
buyers pay
(b) Inelastic Supply, Elastic Demand
3. …than on consumers.
1. When demand is more elastic than supply…
2. …the incidence of the tax falls more heavily on producers...
Fig . Gasoline Tax Falls on both Consumer and Producer
What is the incidence of a tax? A $1 tax on gasoline shifts the supply curve up $1 everywhere, giving a new supply curve, S'S', parallel to the original supply curve, SS. This new supply curve intersects DD at the new equilibrium E', where price to consumers has risen 90 cents and producers’ price has fallen 10 cents. The red arrows show changes in P and Q. Note that consumers bear most of the burden of the tax. (Samuelson, Economics,17th, P78)
P
D
O
D
S
E
E'
S'
S'
X
Quantity (billion of gallons)
Retail Price
Q
50
100
150
S
. Gasoline Tax Falls on both Consumer and Producer
ELASTICITY
AND TAX INCIDENCE
So, how is the burden of the tax divided?
The burden of a tax falls more heavily on the side of the market that is less elastic.
In 1990, Congress adopted a new luxury tax on items such as yachts, private airplanes, furs, jewelry, and expensive cars. The goal of the tax was to raise revenue from those who could most easily afford to pay. Because only the rich could afford to buy such extravagances, taxing luxuries seemed a logical way of taxing the rich.
Case study: Who pays the luxury tax?
Yet, when the forces of supply and demand took over, the outcome was quite different from what Congress intended. Consider, for example, the market for yachts. The demand for yachts is quite elastic. A millionaire can easily not buy a yacht; she can use the money to buy a bigger house, take a European vacation, or leave a larger bequest to her heirs. By contrast, the supply of yachts is relatively inelastic, at least in the short run. Yacht factories are not easily converted to alternative uses, and workers who build yachts are not eager to change careers in response to changing market conditions.
Our analysis makes a clear prediction in this case. With elastic demand and inelastic supply, the burden of a tax falls largely in the suppliers. That is, a tax on yachts places a burden largely in the firms and workers who build yachts because they end up getting a lower price for their product. The workers, however, are not wealthy. Thus, the burden of a luxury tax falls more on the middle class than on the rich.
Case study: Who pays the luxury tax?
The mistaken assumptions about the incidence of the luxury tax quickly became apparent after the tax went into effect. Suppliers of luxuries made their congressional representatives well aware of the economic hardship they experienced, and Congress repealed most of the luxury tax in 1993.
(Mankiw,Principles of Economics(2004), third edition, p130.)
Case study: Who pays the luxury tax?
Summary
Price controls include price ceilings and price floors.
A price ceiling is a legal maximum on the price of a good or service. An example is rent control.
A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage.
Summary
Taxes are used to raise revenue for public purposes.
When the government levies a tax on a good, the equilibrium quantity of the good falls.
A tax on a good places a wedge between the price paid by buyers and the price received by sellers.
Summary
The incidence of a tax refers to who bears the burden of a tax.
The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.
The incidence of the tax depends on the price elasticities of supply and demand.
The burden tends to fall on the side of the market that is less elastic.
Price of
Bus tickets
O
Q'
Number of passenger kilometres
b
d
D
S
e
f
S'
subsidies
S
a
c
Q
1.. The diagram shows the demand and supply for bus travel both before and after a government decision to subsidise bus tickets. Which area represents the total cost of the subsidy to the government?
A. cade
B. bfec
C. obfQ
D. oceQ'
(Mankiw-chapter6.-p130.) Suppose the demand curve for pizza can be represented by the equation QD = 20 - 2P, where QD is the quantity demanded and P is the price. The supply curve of pizza can be represented by the equation QS =P – 1, where QS is the quantity supplied. Suppose the government imposes a $3 tax per pizza. How much more will consumers now pay for a pizza?
Mankiw-p130, Chapter6 Supply, Demand, and government policies
Answer:
Pbuyer =Pseller+T,
so that, (10- Q/2) =(Q+1)+3,
We get Qequilibrium = 4,
We get that Pseller = (Q+1) =5,
Pbuyer = (10- Q/2) = 8,
or Pbuyer = (Q+1)+3 = 8.
Mankiw-p130, Chapter6 Supply, Demand, and government policies
(Mankiw-Chapter6.-p133.-question 10.) The . government administers two programs that affect the market for cigarettes. Media campaigns and labeling requirements are aimed at making the public aware of the dangers of cigarette smoking. At the same time, the Department of Agriculture maintains a price-support program for tobacco farmers, which raises the price of tobacco above the equilibrium price.
How do these two programs affect cigarette consumption? Use a graph of the cigarette market in your answer.
What is the combined effect of these two programs on the price of cigarettes?
Cigarettes are also heavily taxed. What effect does this tax have on cigarette consumption?
Mankiw,p133.-question 10 a..
S2
q3
q1
p3
p1
quantity
Price
Demand for
tobacco
S1
E3
E1
a-2. price-support program
for tobacco farmers
对烟农的价格支持计划
Price
floor
q2
q1
p2
p1
quantity
Price
D2
Demand for cigarette
S
E2
E1
a-1. Media campaign and
labeling requirement
媒体宣传和贴警示语
D1
Mankiw,p133.-question 10 b..
q2
q1
p2
p1
Price
D2
Demand
for cigarette
S1
E2
E1
D1
S2
E3
q3
quantity
q2
q1
p2
p1
Price
D2
Demand
for cigarette
S1
E2
E1
b-2. the combined effect of these two programs on the price of cigarettes
D1
S2
E3
q3
quantity
p3
q2
q1
p2
p1
Price
D2
Demand
for cigarette
S1
E2
E1
b-3. the combined effect of these two programs on the price of cigarettes
D1
S2
E3
q3
quantity
p3
b-1. the combined effect of these two programs on the price of cigarettes
Analysis: A price-support program for tobacco farmers raises the price of tobacco and then increases production-cost of a pack of cigarette. So the graph shows the supply curve shifting upward.
Mankiw,p133.-question 10. c..
q2
q1
p2
p1
Price
D2
Demand
for cigarette
E2
E1
c. the combined effect of these two programs on the price of cigarettes
D1
E4
q3
quantity
p4
q4
E3
S3 (heavily taxes)
S2 (price-support)
S1 (initial supply)
p3
