Supply, Demand and Government Policies Chapter 6

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

Taxes on sellers affect market outcome

-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 -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

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 -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

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 -The rationing mechanisms: not desirable

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

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

Price Controls

-usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers - can generate inequities

How Price Ceilings affect market outcomes

1) Not binding Set above the equilibrium price No effect on the price or qty sold 2) Binding constraint Set below the equilibrium price Shortage Sellers must ration the scares goods (long lines, discrimination according to sellers bias)

Luxury Tax

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 Outcome: -Burden of a tax falls largely on the suppliers •Relatively inelastic supply •1993: most of the luxury tax was repealed

Price Ceiling : Rent conrol

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 Adverse effects in the short run -Supply and demand for housing are relatively inelastic -Small shortage -Reduced rents 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 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 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

Price Floor: Minimum Wage

Price floor: minimum wage -Lowest price for labor that any employer may pay •Fair Labor Standards Act of 1938 -Ensure workers a minimally adequate standard of living •2012, federal minimum wage, $7.25/hour -Some states mandate minimum wages above the federal level •France -Average income is 27% lower than in the U.S. -Minimum wage 9.40 euros per hour ($12) •Market for labor -Workers supply labor -Firms demand labor •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 •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 •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

Taxes

Used to raid revenue for public purposes and influence market outcomes -To raise revenue for public projects •Roads, schools, and national defense

Price Ceiling

a legal maximum on the price at which a good can be sold Rent control, if the price ceiling is below the equilibrium price, then the price ceiling is binding, and the qty demanded exceeds the qty supplied. Because of the resulting shortage, selelrs must in some way ration the good or service among buyers

Price floor

a legal minimum on the price at which a good can be sold Minimum Wage. If the price floor is above the equilibrium price, then the price floor is binding, and the qty supplied exceeds the qty demanded. Becuase of the resulting surplus, buyer's demands for the good or service must in some way be rationed among sellers.

tax incidence

the manner in which the burden of a tax is shared among participates in a market When the government levies a tax on a good, the equilibrium qty of the good falls. That is, a tax on the market shrinks the size of the market Tax on a good places a wedge between the price paid by buyers and the price recieved by sellers. When the market moves to the new equilibrium, buyers pay more for the good and sellers recieve less for it. In this sense, buyers and selelrs share teh tax burden. The incidence f a tax (that is, division of the tax burden) does not depeond on wheater the tax is levied on the buyers or the sllers. Depends on the price elasticities of supply and demand. Most of the burden falls on the side of the market that is less elastice becuase that side of the market is less elastic because that side of the of the amerket cannot respond as easlity to the tax by changing the qty bought or sold

Evaluating Price Controls

•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 •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

Can Congress distribute the burden of a payroll tax?

•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 •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 •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