Supply Demand and Government Policies 10 09 2012 Dissatisfaction with the results of the law of supply and demand is a motivation for government action The dissatisfaction arises from the outcome being politically acceptable o If rents on apartments are seen as too expensive then there may be pressure on the government to regulate the market for apartments An obvious way to try to circumvent the law of supply and demand is to legislate a restriction on the price of a good or service 1 Some government policies that alter a market outcome by interfering with the law of supply and demand o types of price control Price Ceiling a legal maximum on the price of a good or service price Rent control local gvt imposes a maximum legal A market for apartments P price of apartments Q Quantity of apartments o Fixed inelastic supply quantity of apartments o Demand curve o Price Ceiling higher than equilibrium price A price above the equilibrium price is NOT BINDING has no effect on the market outcome o Price Ceiling lower than equilibrium price The ceiling is BINDING on the price and causes a shortage With a shortage the goods must be rationed amongst the buyers Some rationing mechanisms o o o o 1 long waiting lists 2 Preference given to tenants without children 3 Discrimination according to sellers biases ex on the basis of race 4 apts Go to people who are willing to pay bribes to building superintendents Rent control in the long run o Shortages concerns o Landlords lose their incentives to responds to tenants In the long run supply and demand are more price elastic So the shortage is larger o Tenants get lower quality housing 2 Price Floor a legal minimum on the price of a good or service o If wages are believed to be too low then there may be pressure on the government to regulate the labor market Minimum wage laws do not affect highly skilled workers o A market for unskilled labor P Wage Paid to unskilled workers L Q Amount if Demand employers Supply the people employees You supply labor to labor employers o A minimum wage below the equilibrium wage is NOT BINDING and therefore has no effect on the market outcome o A minimum wage above the equilibrium wage is BINIDING on the wage and causes a surplus ex unemployment Labor laws affect o Teen workers Studies show a 10 increase in the minimum wage raises teen unemployment by 1 3 o Farmers participating in the federal commodities programs receive a target floor price for their crops Evaluating Price Controls Prices are the signals that guide the allocation of society s resources This allocation is altered when policymakers restrict prices than help Alternative solutions not work Price controls often intended to help the poor but often hurt more If government is going to try to solve social problems there are good reasons to try another way Attempts to get around the law of supply and demand generally do If government wants higher wages for unskilled labor it can attempt to increase the demand for such labor If it wants affordable housing it can subsidize housing Such methods often generate some problems of their own However these are usually more effective than disregarding the law Understanding the law of supply and demand is important in of supply and demand making public policy Gas Prices Public Policy the price of oil o In 1973 OPEC reduced the supply of oil which in turn raised That in turn reduced the supply of gasoline o At the time US government regulations limited the price that could be charged for gasoline o Before OPEC raised the price of oil the equilibrium price of gasoline was below the price ceiling and the price ceiling had no effect o When the price of oil rose reducing the supply of gasoline the equilibrium price of gasoline went above the price ceiling That caused a shortage As a result some gas stations ran out of gas and there were long lines at gas stations When the supply fell the price ceiling became the that had gas same 10 11 2012 Sales Tax TAX POLICY AND THE LAW OF SUPPLY AND DEMAND o Local Governments state governments and the federal government levy taxes on goods and services to raise revenue to pay for public schools national defense etc o A government can make buyers pay the tax or make the o A tax can be a percentage of the good s percentage price or sellers pay the tax an amount for each unit sold tax is levied on the worker o The magnitude of the wedge does not depend on whether the o A tax leads to lower wages and fewer workers being hired We will analyze per unit taxes o A tax on buyers At any price that could be charged by the sellers the amount the buyers pay is 1 50 higher with the tax than without the tax Start with any initial price after the tax is imposed the price would have to fall by 1 50 for buyers to be willing to buy the same quantity as before For example start with an initial price of 10 Assume a 1 50 tax is imposed and the price falls from 10 to 8 50 Hence the price at which 500 pizzas will be the quantity demanded has decreased by the amount Similar reasoning applies at every other quantity Parallel shift drops down with exact amount of of the tax tax New equilibrium point where supply curve meets new demand curve Price sellers drops Price quantity drops Price buyers fewer quantity available and getting more for each worse Government takes money from participants in the market The Incidence of a Tax How the burden of the tax is shared Buyers pay 1 00 more Sellers get 50 less o A tax on sellers A tax effectively raises seller s costs Sellers will supply only if the price rises to offset the A tax on sellers shifts the supply curve up by the cost increase amount of the tax Incidence of Tax Buyers pay more 1 00 Sellers get 50 less o Whether the tax is imposed on the buyers or the sellers there on same impact is the Amount a buyer pays Amount a seller receives Quantity bought and sold Tax incidence Payroll Taxes o Demand curve shifts to left accordingly with tax Lower wage Fewer hours of work being bought and sold in market o The payroll tax creates a wedge between the cost of an hour of work and what the worker receives o Social Security Financed by payroll tax Required that 50 be paid by worker and 50 paid by employer each one paying 6 2 of worker s income Workers and firms share the burden of the tax Not necessarily shared in the percentages specified in legislation More generally lawmakers can decide whether a tax comes from the buyer s pocket or from the seller s Cannot legislate the
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