Ch 6 Markets in Action Price ceiling and

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Ch. 6: Markets in Action. § Price ceiling and inefficiencies. § Price floors (minimum

Ch. 6: Markets in Action. § Price ceiling and inefficiencies. § Price floors (minimum wage) and inefficiency. § Taxes and inefficiencies

The effect of price ceilings. • Price ceiling is a maximum price. – “binding”

The effect of price ceilings. • Price ceiling is a maximum price. – “binding” only if ceiling is below equilibrium price. – binding price ceiling causes a shortage.

SR & LR effects without price ceiling Suppose equilibrium price of gasoline is $4

SR & LR effects without price ceiling Suppose equilibrium price of gasoline is $4 and a hurricane destroys numerous refineries. Examine SR & LR effects on price and quantity. S $4 D

Compare outcomes with and without a price ceiling at $4 • Shortage • Effect

Compare outcomes with and without a price ceiling at $4 • Shortage • Effect on consumer’s surplus • Effect on producer’s surplus • Deadweight loss • Black markets, search costs, enforcement costs S $4 S-LR D Millions of gallons per day

The effect of price floors • A price floor is a minimum price –

The effect of price floors • A price floor is a minimum price – binding only if it is set above the equilibrium price – binding price floor creates a surplus.

Minimum Wage • Is a price floor on labor. • Why is there a

Minimum Wage • Is a price floor on labor. • Why is there a minimum wage? • Would a higher minimum wage make workers better off? • Efficiency versus equity

The Labor Market and the Minimum Wage Minimum wage is a price floor. Price

The Labor Market and the Minimum Wage Minimum wage is a price floor. Price floor is “binding” only if it is above equilibrium price.

The Labor Market and the Minimum Wage A “binding” price floor • reduces consumer

The Labor Market and the Minimum Wage A “binding” price floor • reduces consumer (employer) surplus • Could increase or decrease producer (employee) surplus • Creates a deadweight loss • Destroys some of the producer surplus (employee) through search activity.

The Effect of Price Floors In general, a “binding” price floor will result in:

The Effect of Price Floors In general, a “binding” price floor will result in: a. Buyers (employers) are worse off b. Sellers (employees) could be better or worse off. c. A deadweight loss.

Taxes • Tax Incidence – the division of the burden of a tax between

Taxes • Tax Incidence – the division of the burden of a tax between the buyer and the seller. – When an item is taxed, its price might rise by the full amount of the tax, by a lesser amount, or not at all. – If the price rises by the full amount of the tax, the buyer pays the tax. – If the price rises by a lesser amount than the tax, the buyer and seller share the burden of the tax. – If the price doesn’t rise at all, the seller pays the tax.

Taxes • Tax Incidence – Tax incidence doesn’t depend on tax law. – The

Taxes • Tax Incidence – Tax incidence doesn’t depend on tax law. – The law might impose a tax on the buyer or the seller, but the outcome will be the same. – Example: On July 1, 2002, Mayor Bloomberg upped the cigarette tax in New York City from almost nothing to $1. 50 a pack.

Tax Incidence .

Tax Incidence .

Taxes • Tax incidence: – Buyer: $1 – Seller : $. 50

Taxes • Tax incidence: – Buyer: $1 – Seller : $. 50

Taxes • A Tax on Buyers – suppose that buyers, not sellers, are taxed

Taxes • A Tax on Buyers – suppose that buyers, not sellers, are taxed $1. 50 a pack. • Tax incidence: – Buyer: $1 – Seller: $. 50

Tax Division and Elasticity of Demand The more inelastic the demand, the larger is

Tax Division and Elasticity of Demand The more inelastic the demand, the larger is the buyers’ share of the tax.

Taxes The more elastic the supply, the larger is the buyers’ share of the

Taxes The more elastic the supply, the larger is the buyers’ share of the tax.

Taxes • Taxes in Practice – Taxes usually are levied on goods and services

Taxes • Taxes in Practice – Taxes usually are levied on goods and services with an inelastic demand or an inelastic supply. – Alcohol, tobacco, and gasoline have inelastic demand, so the buyers of these items pay most the tax on them. – Labor has a low elasticity of supply, so the seller—the worker—pays most of the income tax and most of the Social Security tax.

Taxes create allocative inefficiency unless S or D is perfectly inelastic. • What’s effect

Taxes create allocative inefficiency unless S or D is perfectly inelastic. • What’s effect of tax on 1. 2. 3. 4. • Consumer surplus Producer surplus Tax revenue Deadweight loss Excess burden of tax § § reduction in consumer & producer surplus minus tax revenue Identical to deadweight loss

Subsidies and Quotas – Fluctuations in the weather bring big fluctuations in farm output.

Subsidies and Quotas – Fluctuations in the weather bring big fluctuations in farm output. – How do changes in farm output affect the prices of farm products and farm revenues? – How might farmers be helped by intervention in markets for farm products?

Stabilizing Farm Revenues – A poor harvest decreases supply. § Effect on total revenue?

Stabilizing Farm Revenues – A poor harvest decreases supply. § Effect on total revenue? • higher price • lower quantity § How would answer change if demand were elastic?

Stabilizing Farm Revenues – A large harvest increases supply. – Effect on total revenue?

Stabilizing Farm Revenues – A large harvest increases supply. – Effect on total revenue? • Lower price • Higher quantity – How would answer change if demand were elastic?

Stabilizing Farm Revenues Intervention in markets for farm products takes two main forms: §

Stabilizing Farm Revenues Intervention in markets for farm products takes two main forms: § Subsidies a payment made by the government to a producer that’s in addition to market price received. § Production quotas an upper limit on the quantity of a good that may be produced during a specified period.

Subsidies Effect of $20 subsidy • Equilibrium quantity • Equilibrium price • Consumer surplus

Subsidies Effect of $20 subsidy • Equilibrium quantity • Equilibrium price • Consumer surplus • Producer surplus • Cost to taxpayers • Deadweight loss

The $20 subsidy would cause consumers to be a) b) c) d) $500 million

The $20 subsidy would cause consumers to be a) b) c) d) $500 million better off $600 million better off $400 million worse off 10

Quotas • Maximum production allowed. • Binding only if below equil quantity • limits

Quotas • Maximum production allowed. • Binding only if below equil quantity • limits total production to 40 million tons a year. • Effect on – Price – Consumer’s surplus – Producer’s surplus – Deadweight loss – Price of license