ch. 6: markets in action
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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” only if ceiling is below equilibrium price. - PowerPoint PPT PresentationTRANSCRIPT
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Ch. 6: Markets in Action.
Price ceiling and inefficiencies. Price floors (minimum wage) and inefficiency. Taxes and inefficiencies
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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.
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SR & LR effects without price ceiling
S
D
$4
Suppose equilibrium price of gasoline is $4 and a hurricane destroys numerous refineries. Examine SR & LR effects on price and quantity.
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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
D
$4 S-LR
Millions of gallons per day
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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.
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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
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The Labor Market and the Minimum Wage
Minimum wage isa price floor.
Price floor is “binding” only if it is above equilibrium price.
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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.
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The Effect of Price Floors
In general, a “binding” price floor will result in:a. Buyers (employers) are worse offb. Sellers (employees) could be better or worse off. c. A deadweight loss.
S
D
1000
$2
500
$1
$3 ab
cd
ef
1500
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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.
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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.
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Tax Incidence
.
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Taxes
• Tax incidence:– Buyer: $1– Seller : $.50
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Taxes
• A Tax on Buyers– suppose that
buyers, not sellers, are taxed $1.50 a pack.
• Tax incidence:– Buyer: $1– Seller: $.50
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Tax Division and Elasticity of Demand
The more inelastic the demand, the larger is the buyers’ share of the tax.
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Taxes
The more elastic the supply, the larger is the buyers’ share of the tax.
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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 of 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.
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TaxesTaxes create allocative
inefficiency unless S or D is perfectly inelastic.
• What’s effect of tax on1. Consumer surplus2. Producer surplus3. Tax revenue4. Deadweight loss
• Excess burden of tax reduction in consumer &
producer surplus minus tax revenue
Identical to deadweight loss
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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?
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Stabilizing Farm Revenues
– A poor harvest decreases supply.
Effect on total revenue?• higher price• lower quantity
How would answer change if demand were elastic?
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Stabilizing Farm Revenues
– A large harvest increases supply.
– Effect on total revenue?• Lower price• Higher quantity
– How would answer change if demand were elastic?
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Stabilizing Farm Revenues
Intervention in markets for farm products takes two main forms:
Subsidiesa 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.
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Subsidies
Effect of $20 subsidy• Equilibrium quantity• Equilibrium price • Consumer surplus• Producer surplus• Cost to taxpayers• Deadweight loss
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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