copyright © 2004 south-western ch. 4a: economic efficiency, government price setting, and taxes...

Copyright © 2004 South-Western

Ch. 4a: Economic efficiency, Government Price Setting , and Taxes

1. Price Ceilings- A legally set maximum price below the market equilibrium price that sellers may charge for a good or service.

2. Governments set a maximum price below the market equilibrium price (binding price ceiling) to help consumers

3. Examples: Rent control in NYC, or Berkley; Sport salary caps, Home owner’s insurance control; and gasoline price controls in the 1970s.

■ The results were long lines at service stations.■ Service stations were forced to close because they

had no gasoline (shortage).

1. Price Ceilings- A legally set maximum price below the market equilibrium price that sellers may charge for a good or service.

2. Governments set a maximum price below the market equilibrium price (binding price ceiling) to help consumers

3. Examples: Rent control in NYC, or Berkley; Sport salary caps, Home owner’s insurance control; and gasoline price controls in the 1970s.

■ The results were long lines at service stations.■ Service stations were forced to close because they

had no gasoline (shortage).


S

D

Pceiled

Pe

Binding Price Ceiling

Binding Price Ceiling


Price Ceiling

4. A binding price ceiling results in a shortage because buyers want more than what sellers are willing to offer

Shortage = Qd -Qs

5. Government must institute some rationing system to deal with the shortage

First-come, first-served Rationing tickets or cards

4. A binding price ceiling results in a shortage because buyers want more than what sellers are willing to offer

Shortage = Qd -Qs

5. Government must institute some rationing system to deal with the shortage

First-come, first-served Rationing tickets or cards


Binding vs non-binding price ceiling

6. A binding price-ceiling occurs when the price is set below the market eq. price

A binding price-ceiling benefits the consumers in the short-run.

A non-binding price-ceiling occurs when the price is set above the market eq. price.

6. A binding price-ceiling occurs when the price is set below the market eq. price

A binding price-ceiling benefits the consumers in the short-run.

A non-binding price-ceiling occurs when the price is set above the market eq. price.


A Non-Binding Price Ceiling

Price

Quantity

Supply

PCeiled

PE

QE

Price Ceiling

Demand


6. Price Floors (support)

7. Price floor- a legally set minimum price above the market eq. price (binding price floor) that sellers are guaranteed to charge

Note: The purpose of price support(floor) is to help producers

7. Price floor- a legally set minimum price above the market eq. price (binding price floor) that sellers are guaranteed to charge

Note: The purpose of price support(floor) is to help producers


A Binding Price Floor

Price

Quantity

Supply

PF

PE

QE

Price Floor

Demand


A Binding Price Floor

8. Examples Dairy price support Tobacco price support Minimum wage laws- Economists disagree about the

effects of minimum wage. Some say it reduces employment; others say, it has no effect on employment. It depends on the labor market type

9. The government sets a legal minimum above the market equilibrium price for dairy, tobacco, soybeans, etc. to help producers

10. Price floor or support will result in a surplus.

8. Examples Dairy price support Tobacco price support Minimum wage laws- Economists disagree about the

effects of minimum wage. Some say it reduces employment; others say, it has no effect on employment. It depends on the labor market type

9. The government sets a legal minimum above the market equilibrium price for dairy, tobacco, soybeans, etc. to help producers

10. Price floor or support will result in a surplus.


11. Binding and Non-binding Price Floor or Support

● A binding price floor occurs when price set above the market equilibrium price.

● A non-binding price floor occurs when price set below the market equilibrium price.

● Example: Impact of minimum wage policy on manufacturing wage and employment

● A binding price floor occurs when price set above the market equilibrium price.

● A non-binding price floor occurs when price set below the market equilibrium price.

● Example: Impact of minimum wage policy on manufacturing wage and employment


Example of Minimum Prices: The Federal Minimum Wage

●The federal minimum wage was established by the Fair Labor Standards Act of 1938. Originally the minimum wage was set at $0.25 per hour and covered approximately 43 percent of all non-supervisory employees in private nonagricultural jobs.

●The federal minimum wage was established by the Fair Labor Standards Act of 1938. Originally the minimum wage was set at $0.25 per hour and covered approximately 43 percent of all non-supervisory employees in private nonagricultural jobs.


Minimum Wage Legislation

● The law was last amended in August 1996 when the existing minimum of $4.25 was raised in two steps, to $4.75 on October 1, 1996, and then to $5.15 on September 1, 1997.

● The current law provides for a “training wage” of $4.25 per hour for teenagers in the first 90 days of employment.

● Approximately 90 percent of the labor force is now covered.

● The law was last amended in August 1996 when the existing minimum of $4.25 was raised in two steps, to $4.75 on October 1, 1996, and then to $5.15 on September 1, 1997.

● The current law provides for a “training wage” of $4.25 per hour for teenagers in the first 90 days of employment.

● Approximately 90 percent of the labor force is now covered.


Minimum Wage Legislation

● Most states have established their own laws that extend minimum wages to workers not covered by federal law and in a few instances sets the level above the federal level.

● Economists disagree about the impact of minimum wage laws, but the latest increase probably had a small effect on employment.

● Most states have established their own laws that extend minimum wages to workers not covered by federal law and in a few instances sets the level above the federal level.

● Economists disagree about the impact of minimum wage laws, but the latest increase probably had a small effect on employment.


Agricultural Prices

●Milk

●The Freedom to Farm Act and recent developments

●Milk

●The Freedom to Farm Act and recent developments


Price floor

10. A binding price floor results in a surplus because sellers are willing to offer more than what buyers can afford to buy at a price above the eq. price

Surplus = Qs–Qd

11. A binding price floor occurs when price is set above the equilibrium price

A non-binding price floor occurs when price is set below the equilibrium price

12. The effect of the minimum wage depends on the type of labor market (youth vs skilled workers). It reduces the employment of the youth and has no immediate effect on the employment of skilled workers

10. A binding price floor results in a surplus because sellers are willing to offer more than what buyers can afford to buy at a price above the eq. price

Surplus = Qs–Qd

11. A binding price floor occurs when price is set above the equilibrium price

A non-binding price floor occurs when price is set below the equilibrium price

12. The effect of the minimum wage depends on the type of labor market (youth vs skilled workers). It reduces the employment of the youth and has no immediate effect on the employment of skilled workers


13. Taxes

●How do taxes affect the decisions of buyers and sellers?

●Tax incidence is burden of taxation.

●How do taxes affect the decisions of buyers and sellers?

●Tax incidence is burden of taxation.


Taxes: Impact of a 50 Cent Tax from Buyer’s Viewpoint

From the buyer’s viewpoint, the tax causes the demand curve to shift down by 50 cents.

90 100

$3.30

$3.00

$2.80



90 100

$3.30

$3.00

$2.80

The tax increases the market price to the buyer . . .

. . . and decreases demand.



90 100

$3.30

$3.00

$2.80 The tax decreases the return to the seller.



90 100

$3.30

$3.00

$2.80

The tax makes both the buyer and the seller worse off!


Prohibitions and Rationing

● What is the effect on the demand for goods and services that are prohibited?

■Embargoes

■Street drugs

■Prohibition (18th Amendment to the U.S. Constitution)

● What is the effect on the demand for goods and services that are prohibited?

■Embargoes

■Street drugs

■Prohibition (18th Amendment to the U.S. Constitution)


The Impact of an Excise Tax – Sellers Collect the Tax

Specific Tax $.50


Examples of Taxes & Subsidies

● Taxes

■What happens to the supply of cigarettes if the taxes per pack are increased?

■Why do the anti-smokers want to increase the Federal tax on cigarettes?

■Tax subsidy

● Taxes

■What happens to the supply of cigarettes if the taxes per pack are increased?

■Why do the anti-smokers want to increase the Federal tax on cigarettes?

■Tax subsidy


Examples of Tax & Subsidies

● A subsidy is like a negative tax; instead of raising the price, it lowers the price.

● How is the demand for higher education affected as the public subsidy increases or decreases?

● In 1996 the farm subsidy changed radically (decreased).

● One exception is Tobacco Farming.

● A subsidy is like a negative tax; instead of raising the price, it lowers the price.

● How is the demand for higher education affected as the public subsidy increases or decreases?

● In 1996 the farm subsidy changed radically (decreased).

● One exception is Tobacco Farming.


Elasticity and Tax Incidence

● The more realistic the demand for the product, the more the burden falls on buyers.

● The more elastic the demand for the product, the more the burden falls on sellers.

● The more inelastic the supply of the product, the more the burden falls on sellers.

● The more realistic the demand for the product, the more the burden falls on buyers.

● The more elastic the demand for the product, the more the burden falls on sellers.

● The more inelastic the supply of the product, the more the burden falls on sellers.


Elasticity and Tax Incidence

Price

Quantity

Tax paid by buyer

Tax paid by seller

Amt. of tax


Other Government Policies

● Regulation (cigarettes)■ What happens to the supply of automobiles if new

environmental regulations are imposed?■ Truck safety■ What happens to the demand for goods and services

that are prohibited?

● Milk and marketing orders

● Airports

● Regulation (cigarettes)■ What happens to the supply of automobiles if new

environmental regulations are imposed?■ Truck safety■ What happens to the demand for goods and services

that are prohibited?

● Milk and marketing orders

● Airports

copyright © 2004 south-western ch. 4a: economic efficiency, government price setting, and taxes...

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