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.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.types of price control:Price Ceiling: a legal maximum on the price of a good or service.Rent control- local gvt imposes a maximum legal price.A market for apartments:P= price of apartments Q= Quantity of apartments.Fixed (inelastic) supply (quantity of apartments)Demand curvePrice Ceiling (higher than equilibrium price)A price above the equilibrium price is NOT BINDING- has no effect on the market outcome.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 buyersSome rationing mechanisms:(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:Shortages.Landlords lose their incentives to responds to tenants’ concerns.In the long run, supply and demand are more price elastic. So the shortage is larger.Tenants get lower-quality housing.2. Price Floor: a legal minimum on the price of a good or service.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.A market for unskilled labor:P= Wage Paid to unskilled workers L(Q)=Amount if labor.Demand: employersSupply: the people (employees). You supply labor to employers.A minimum wage below the equilibrium wage is NOT BINDING and therefore has no effect on the market outcome.A minimum wage above the equilibrium wage is BINIDING on the wage and causes a surplus (ex:unemployment).Labor laws affect:Teen workersStudies show a 10% increase in the minimum wage raises teen unemployment by 1-3%Farmers participating in the federal commodities programs receive a target (floor) price for their crops.Evaluating Price ControlsPrices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices.Price controls often intended to help the poor, but often hurt more than help.If government is going to try to solve social problems, there are good reasons to try another way.Alternative solutionsAttempts to get around the law of supply and demand generally do not work.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 of supply and demand.Understanding the law of supply and demand is important in making public policy.Gas Prices & Public Policy:In 1973, OPEC reduced the supply of oil (which, in turn, raised the price of oil).That in turn, reduced the supply of gasoline.At the time, US government regulations limited the price that could be charged for gasoline.Before OPEC raised the price of oil, the equilibrium price of gasoline was below the price ceiling and the price ceiling had no effect.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 that had gas.When the supply fell, the price ceiling became the same.10-11-2012TAX POLICY AND THE LAW OF SUPPLY AND DEMANDSales TaxLocal Governments, state governments, and the federal government levy taxes on goods and services (to raise revenue to pay for public schools, national defense, etc.)A government can make buyers pay the tax or make the sellers pay the tax.A tax can be a percentage of the good’s percentage price or an amount for each unit sold.The magnitude of the wedge does not depend on whether the tax is levied on the worker.A tax leads to lower wages and fewer workers being hired.We will analyze per unit taxesA tax on buyersAt 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 of the tax.Similar reasoning applies at every other quantity.Parallel shift, drops down with exact amount of tax.New equilibrium: point where supply curve meets new demand curve.Price sellers: drops, Price quantity: dropsPrice buyers: fewer quantity available and getting more for each. (worse)Government takes money from participants in the market.The Incidence of a TaxHow the burden of the tax is shared.Buyers pay 1.00 moreSellers get .50 lessA tax on sellersA tax effectively raises seller’s costsSellers will supply only if the price rises to offset the cost increase.A tax on sellers shifts the supply curve up by the amount of the tax.Incidence of TaxBuyers pay more (1.00)Sellers get .50 lessWhether the tax is imposed on the buyers or the sellers, there is the same impact onAmount a buyer paysAmount a seller receivesQuantity bought and soldTax incidencePayroll TaxesDemand curve shifts to left accordingly with taxLower wageFewer hours of work being bought and sold in market.The payroll tax creates a wedge between the cost of an hour of work and what the worker receives.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 taxNot 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’sCannot legislate the true burden of a
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