Applications of Supply and Demand Chapter 4 Price Controls Floor Ceilings Who benefits from each:...

Applications of Supply and Demand

Chapter 4

Price Controls

• Floor

• Ceilings

Who benefits from each: sellers or buyers?

Figure 1 A Market with a Price Ceiling

(a) A Price Ceiling That Is Not Binding

Quantity ofIce-Cream

Cones

0

Price ofIce-Cream

Cone

Equilibriumquantity

$4 Priceceiling

Equilibriumprice

Demand

Supply

3

100

Figure 1 A Market with a Price Ceiling

Copyright©2003 Southwestern/Thomson Learning

(b) A Price Ceiling That Is Binding


Cones

0

Price ofIce-Cream

Cone

Demand

Supply

2 PriceceilingShortage

75

Quantitysupplied

125

Quantitydemanded

Equilibriumprice

$3

Price Gouging

• What is the difference between price gouging and acting in accordance with the laws of supply and demand?

• Should it be illegal?

Rent Control

Ceiling or floor?

Rationale?

One economist called rent control “the best way to destroy a city, other than bombing.”

Figure 3 Rent Control in the Short Run and in the Long Run


(a) Rent Control in the Short Run(supply and demand are inelastic)

Quantity ofApartments

0

Supply

Controlled rent

RentalPrice of

Apartment

Demand

Shortage

Figure 3 Rent Control in the Short Run and in the Long Run


(b) Rent Control in the Long Run(supply and demand are elastic)

0

RentalPrice of

Apartment

Quantity ofApartments

Demand

Supply

Controlled rent

Shortage

• Shortages and black markets will develop.• The future supply of housing will decline.• The quality of housing will deteriorate.• Non-price methods of rationing will

increase in importance.

Effects of Rent Control

• Inefficient use of housing will result.• Long-term renters will benefit at the

expense of newcomers.

Figure 4 A Market with a Price Floor


(a) A Price Floor That Is Not Binding


Cones

0

Price ofIce-Cream

Cone

Equilibriumquantity

2

Pricefloor

Equilibriumprice

Demand

Supply

$3

100

Figure 4 A Market with a Price Floor


(b) A Price Floor That Is Binding


Cones

0

Price ofIce-Cream

Cone

Demand

Supply

$4Pricefloor

80

Quantitydemanded

120

Quantitysupplied

Equilibriumprice

Surplus

3

Minimum Wage

Figure 5 How the Minimum Wage Affects the Labor Market


Quantity ofLabor

Wage

0

Labordemand

LaborSupply

Equilibriumemployment

Equilibriumwage

Figure 5 How the Minimum Wage Affects the Labor Market


Quantity ofLabor

Wage

0

LaborSupplyLabor surplus

(unemployment)

Labordemand

Minimumwage

Quantitydemanded

Quantitysupplied

Taxes & Subsidies

Figure 6 A Tax on Buyers


Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

Pricewithout

tax

Pricesellersreceive

Equilibrium without taxTax ($0.50)

Pricebuyers

pay

D1

D2

Supply, S1

A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).

$3.30

90

Equilibriumwith tax

2.803.00

100

Figure 7 A Tax on Sellers


2.80

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

Pricewithout

tax

Pricesellersreceive

Equilibriumwith tax

Equilibrium without tax

Tax ($0.50)

Pricebuyers

payS1

S2

Demand, D1

A tax on sellersshifts the supplycurve upwardby the amount ofthe tax ($0.50).

3.00

100

$3.30

90

Figure 9 How the Burden of a Tax Is Divided


Quantity0

Price

Demand

Supply

Tax

Price sellersreceive

Price buyers pay

(a) Elastic Supply, Inelastic Demand

2. . . . theincidence of thetax falls moreheavily onconsumers . . .

1. When supply is more elasticthan demand . . .

Price without tax

3. . . . than on producers.

Figure 9 How the Burden of a Tax Is Divided


Quantity0

Price

Demand

Supply

Tax


Price buyers pay

(b) Inelastic Supply, Elastic Demand

3. . . . than onconsumers.

1. When demand is more elasticthan supply . . .

Price without tax

2. . . . theincidence of the tax falls more heavily on producers . . .

Tax Revenue

If tax is $T per unit, tax revenue equals …

TQ

Recall …

Consumer Surplus:

Area under demand curve and above price line.

Producer Surplus:

Area above supply curve and below price line.

Figure 3 How a Tax Effects Welfare

Copyright © 2004 South-Western

A

F

B

D

C

E

Quantity0

Price

Demand

Supply

= PB

Q2

= PS

Pricebuyers

pay

Pricesellers

receive

= P1

Q1

Pricewithout tax

Deadweight Loss

The fall in total surplus that results from a market distortion, such as a tax.

Buyers have an incentive to consume less and sellers an incentive to produce less.

Ronald Reagan’s Deadweight Loss

I came into the Big Money making pictures during WWII. You could only make four pictures and then you were in the top bracket. So we all quit working after four pictures and went off to the country.

Tax rate(percent)

Tax revenues

25

50

75

100

Maximum

The Laffer Curve

A

C

B

• The average tax rate equals tax liability divided by taxable income.– A progressive tax is one in which the

average tax rate rises with income.– A proportional tax is one in which the

average tax rate stays the same across income levels.

– A regressive tax is one in which the average tax rate falls with income.

Average Tax Rate

• Marginal tax rate: calculated as the change in tax liability divided by the change in taxable income.

• What is the tax on the last dollar earned?

Marginal Tax Rate

Marginal Tax Rate2003 Tax Table Continued

If line 40(taxableincome) is

And you are

Atleast

Butlessthan

Single Marriedfilingjointly

Marriedfilingseparately

Head of a house-hold

$32,000

Your tax is …

32000320503210032150

32200322503230032350

32400324503250032550

32050321003215032200

32250323003235032400

32450325003255032600

4816482948414854

4866487948914904

4916492949414954

4101411141194126

4134414141494156

4164417141794186

4816482948414854

4866487948914904

4916492949414954

4304431143194326

4334434143494356

4364437143794386

• An excerpt from the 2003 federal income tax table is shown here.• Note, for single individuals,

as income increases from $32,000 to $32,100 …

• In this range, what is the individual’s marginal tax rate?

• What is the individual’s average income tax rate?

their tax liability increases from $4,816 to $4,841.

Applications of Supply and Demand Chapter 4 Price Controls Floor Ceilings Who benefits from each:...

Documents

Transcript of Applications of Supply and Demand Chapter 4 Price Controls Floor Ceilings Who benefits from each:...