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Chapter 6

Chapter 6 Economics.docx

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Department
Economics
Course Code
Economics 10a
Professor
Gregory Mankiw

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Chapter 6: Supply, Demand, and Government Policies • Price ceiling: a legal maximum on the price at which a good can be sold (generally benefits consumers) • Two possible outcomes of a price ceiling: o If the price ceiling is above the equilibrium price, then it is not bindingMarket forces naturally move the economy to the equilibrium and the price ceiling has no effect on the price or the quantity sold o If the price ceiling is below the equilibrium price, then it is bindingBecause the market price naturally tries to move toward the equilibrium price, a price ceiling that is below the equilibrium price is binding because the market price can not move above it (toward the equilibrium price) by law  This creates a shortage in the marketresponses of rationing (long lines, producer personal biases) will naturally develop  Comparatively, the rationing mechanism in a free, competitive market is efficient and impersonalnatural forces move price and quantity toward equilibrium, creating natural rationing via price • Price floor: a legal minimum on the price at which a good can be sold (generally benefits producers) • Two possible outcomes of a price floor: o If the price floor is below the equilibrium price, it is not bindingMarket forces naturally move the economy toward the equilibrium, rendering the price floor ineffective o If the price floor is above the equilibrium price, it is bindingthe forces of supply and demand will move the price toward the equilibrium price, but when the market price hits the floor, it can fall no further  This creates a surplus in the marketresponses of rationing (consumer personal biases)  Comparatively, rationing in a free market is controlled by pricesellers can sell all they want at equilibrium • Not all citizens benefit from price controls o With binding price ceilings, some buyers get to pay a lower price, but some citizens get nothing at all o Price controls are often aimed at helping the poor o The government should not institute price controls and should instead subsidize rent, etc. which doesn’t reduce quantity o Alternative to minimum wage: earned income tax credit: government program that supplements the incomes of low-wage workers • Tax incidence: the manner in which the burden of the tax is shared among participants in a market • How Taxes on Sellers Affect Market Outcomes: o Step 1: Does the law affect the supply curve or the demand curve?  Because the immediate impact is on the sellers of the ice cream, it will not affect the quantity demanded by buyers, leaving the demand curve the same. • The supply curve shifts because it makes business less profitable for sellers, so they will produce less supply o Step 2: Which way does the curve shift?  Because the tax on sellers raises the cost of producing and selling the product, the quantity supplied is reduced at every pricethe supply curve shifts left/upward  Linear transformation of subtracting the tax from every point on the supply curve to determine post-tax line o Step 3: How does the shift affect the equilibrium price and quantity?  Compare the pre- and post-tax equilibrium values
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