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Lecture 8

Lecture 8-Supply, Demand and Government Policy

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Department
Economics
Course
ECO101H1
Professor
Jack Carr
Semester
Fall

Description
Thursday, October 8, 2009. Supply, Demand, and Government Policy Theme Government intervention in competitive markets is not helpful. The Impact of Price Ceiling Observations 1. Price ceiling, if beneath the market clearing price, creates shortages. 2. Principle of voluntary exchange: Q (P) = minimum [QD(P), QS(P)] 3. Non-price rationing 4. 7KRVHDEOHWREX\DWWKHSULFHFHLOLQJFRXOGUHVHOOWRRWKHUEX\HUVDWWKH³%ODFN0DUNHW´SULFHRI SS Q P DD 12 16 Price Ceiling Shortage 8 www.notesolution.com Rent Ceiling Economic Concerns with Rent Controls 1) Shortage 2) Incentive Effects - discourages construction (shortage worsens in long run) - discourages maintenance 3) Non-price rationing - inefficient (search time, opportunity cost) - ODQGORUGV³FKRRVH´WHQDQWV 4) Not targeted to poor (single parent or doctor as preferred tenant?) Price Floor SS Q P DD QS Shortage QD Rent Ceiling SS Q P DD QD Surplus QS Price Floor www.notesolution.com 2. Application: Minimum Wage (1) Labour surplus (unemployment) (2) Teenagers: Most affected (3) Reduces opportunity for on-the-job training Minimum Wage: Three Possibilities (1) At less than $6 Minimum Wage = $5.00 No Impact (2) At $6 Minimum Wage = $6.00 No Impact (3) At more than $6 Minimum Wage = $6.00 Employment Falls, Unemployment Rises Earned Income Tax Credit as Alternative to Increase in the Minimum Wage 1. Minimum Wage $6.00 2. Earned Tax Credit* $1.00 _____ $7.00 Effective Wage *targeted (say) single-parents or adults SS Q DD Unskilled Labour 200 $6 $7 $5 Minimum = $7 Minimum = $5 Wage Rate www.notesolution.com The Incidence of a Sales Tax 1. Refers to ultimate burden of tax Measured by higher price paid by buyers and lower price received by sellers. 2. Key Results: (1) Does not depend on whether tax is levies on buyers or sellers. (2) Does depend upon the elasticities of demand and supply. Case #1: Sales Tax Levied on Sellers No Tax Sellers Pay $10 Tax P QD QS P QD QS 120 1 9 120 1 7 115 2 8 115 2 6 110 3 7 110 3 5 105 4 6 105 4 4 100 5 5 100 5 3 95 6 4 95 6 2 90 7 3 90 7 1 85 8 2 85 8 80 9 1 P = 100 P = 105 Q = 5 Q = 4 Price paid by buyer: 100 Price paid by buyer: 105 Price received by seller: 100 Price received by seller: 95 (P ± 10) SS P0+10 $10 P0 SS1 If sales tax of $10 is imposed on sellers, SS shifts upward by $10 Ù for any quantity supplied, price must rise by $10 www.notesolution.com Example Q0 = 5 P0 = 100 P0 + 10 = 110 $10 Tax Levied On Sellers Price paid by buyer: 105 Price received by seller: 105 ± 10 = 95 Case #2: Sales Tax Levied on Buyers No Tax Buyers Pay $10 Tax P QD QS P QD QS 120 1 9 120 9 115 2 8 115 8 110 3 7 110 1 7 105 4 6 105 2 6 100 5 5 100 3 5 95 6 4 95 4 4 90 7 3 90 5 3 85 8 2 85 6 2 80 9 1 80 7 1 P =100 P = 95 Q = 5 Q = 4 Price paid by buyer: 100 Price paid by buyer: 105 (P+10) Price received by seller: 100 Price received by seller: 95 SS1 Q P DD 105 $10 Tax 95 SS 100 www.notesolution.com DD Shifts Vertically Downward by $10 if $10 Tax is Levied on Buyers $10 Tax Levied on Buyers Price paid by buyers: 95 + 10 = 105 Price received by seller: 95 (simply the market price) Tax Incidence and Elasticities of Demand and Supply Consider: (1) extreme cases (2) tax levied on sellers (since incidence is the same when levied on buyers) Demand Elasticities and the Incidence of a Tax $10 Tax to be Paid by Seller DD Q P DD1 Æ110 3 $10 100 DD1 Q P DD $105 $10 Tax $95 SS $100 4 5 www.notesolution.com Perfectly Inelastic Demand Buyer pays: P1 = P0 + 10 (full incidence) Seller receives: P1 ± 10 = (P0 + 10) ± 10 = P0 (no change) Perfectly Elastic Demand Buyer pays: P1 = P0 (no change) Seller receives: P1 ± 10 = P0 ± 10 (full incidence) DD Q0 = Q1 SS P0 P1 = P0 + 10 $10 SS1 DD P1 = P0 $10 SS SS1 Q1 Q0 www.notesolution.com Perfectly Elastic Supply Buyer pays: P1 = P0 + 10 Seller receives: P1 ± 10 = P0 Perfectly Inelastic Supply How to show? Insight: same result if tax imposed on buyers DD P1 = P0 + 10 $10 SS SS1 Q1 Q0 P0 P0 DD Q0 SS www.notesolution.com Price paid by buyers: (P0 ± 10) + 10 = P0 (no change) Price received by seller: P1 = P0 ± 10 (full incidence) Special Case Full Tax is Paid by Perfectly inelastic demand buyers Perfectly elastic demand sellers Perfectly elastic supply buyers Perfectly inelastic supply sellers P0 DD Q0 SS DD1 P1 = P0 ± 10 $10 www.notesolution.comThursday, October 8, 2009. Supply, Demand, and Government Policy Theme Government intervention in competitive markets is not helpful. The Impact of Price Ceiling SS P 12 8 Price Ceiling Shortage DD 16 Q Observations 1. Price ceiling, ifeath the market clearing price, creates shortages. 2. Principle of voluntary exchange: Q (P) = minimum [Q (P), Q (P)] 3. Non-price rationing 4. %K480,-O094-:,99K057L.0.0LOL3J.4:O7080OO9449K07-:078,99K0O,.N ,7N0957L.041 www.notesolution.com
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