Chapter+6+-+Supply,+Demand,+And+Government+Policies+CDJ

=Chapter 6: Supply, Demand and Government Policies =

We first look at different types of policies. There are policies in which it directly controls prices. Some include //rent-control laws//, //and minimum wage laws.// **Price controls** are put when the policy makers think that the price of a good is unfair to either buyers or sellers.

Then there is //tax.// Why do policy makers place tax? They do this to improve or increase market outcomes and to raise the revenue to provide public services. Now, we’re going to closely examine the effects of these policies by looking at the supply & demand curve.

Picture: http://bloggery.wlu.edu/spectator/minwage.gif

Terms you need to know:

 * **Price Ceiling:** a maximum price at which a good can be sold
 * **Price Floor:** a minimum price  at which a good can be sold


2 outcomes are possible when a price ceiling is placed on a good.


Let’s say in this case, chocolates. Let’s also say that the equilibrium price of these chocolates is $2.


Now if the price ceiling of $3 is placed on the chocolates, it is “not binding” bec


ause the E. price is below the ceiling. For this reason, the price ceiling has no effect on the price or the quantity sold.

On the other-hand, this time, the price ceiling place on a good is $ 1. The E. price is above the price ceiling so it is a “binding constraint” on the market; therefore, the price moves towards the ceiling. Once it hits the ceiling, the price can’t go up any further so the market price becomes the price ceiling. Since the price can’t go up any further, the quantity demanded for the chocolates is greater than the quantity supplied which results in a shortage. This means that some people who want chocolates won’t be able to buy them at this price.

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How Price Floors Affect Market Outcomes
Like price ceilings, price floors is placed by the government to keep prices at a different level than the equilibrium level. This time, they impose a minimum price. Again, two outcomes are possible. Let’s say the government places $2 price floor on a lollipop and the equilibrium price is $4. In this case, the equilibrium price is higher than the price floor therefore it is “not binding”

On the other-hand, if the price floor on a good is $5, the equilibrium price is lower than the price floor so it is a “binding constraint” on the market. When the market price hits the price floor, it can’t drop anymore so the market price = the price floor. At this stage, surplus occurs because the quantity supplied is greater than the quantity demanded. Sellers who want to sell lollipops is unable to do so.

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= WHY ...//__TAXES ? !__// =

GOVERNMENT use taxes to build public projects such as roads and schools.

http://i7.photobucket.com/albums/y289/tecknopuppy/tax.jpg Then we need to ask ourselves one vital question: If government decides to levy taxes on certain good, who will bear the burden of the tax? Consumers **__OR__** Producers? !! *But keep in mind of the term, **tax incidence**, which will be used to answer the question above. //**Tax incidence** is a term to describe when tax is shared among the consumers and producers in the market.//

The question above will be answered through 2 sections:

1) How Taxes on Buyers Affect Market Outcomes
**Step 1**: When the tax is levied on buyers, the tax will cause the demand curve to shift, while having the supply curve to be not affected. **Step 2**: The demand curve will shift to the left because taxing will cause the buyers to demand less quantity at every price. **Step 3**: With the effect of the tax, we can compare the initial equilibrium with the new equilibrium: equilibrium price and quantity will both fall.

 **Implication**: After going through the three steps, we can now go back to term tax incidence to answer question, "who will bear the burden of the tax". In this case when tax was levied on buyers, the buyers and sellers both share the burden. How? take a look at the graph below. Graph:

Say $1 tax is levied on buyers. Then with the three steps, we will be able to determine that first, the demand curve will **shift down ** by $1, //causing// equilibrium quantity //to __fall__// from Q1 to Q2 and equilibrium price //to __fall__// from P1 to P2. Moreover, the price that sellers receive falls from $3.20 to $2.80 and the price that the buyers pay will rise from $3.20 to $3.80. Here, we could see that the sellers receive $0.40 less than they did without the tax and that buyers pay has rose $0.60, which tax has made both of them worse off<span style="font-size: 120%; background-color: rgb(11, 137, 54)">.

Therefore, although the tax was levied on the buyers, it shows that buyers and sellers <span style="font-size: 140%; color: rgb(215, 15, 15)">share the burden of the tax. Picture: http://truthintaxation.us/images/toon_midman.jpg

<span style="color: rgb(40, 15, 153)">2) How Taxes on Sellers Affect Market Outcomes
media type="file" key="econ.m4a" Graph:
 * <span style="font-size: 120%; color: rgb(148, 0, 255)">Listen ** to the audio below,

<span style="color: rgb(219, 65, 15)"> <span style="color: rgb(219, 65, 15)">No matter whom the government taxes,
 * <span style="font-size: 130%; color: rgb(62, 84, 234)">Therefore **, the question, If government decides to levy taxes on certain good, who will bear the burden of the tax? Consumers **__OR__** Producers?, was able to be answered with a simple answer:

consumers and producers will **<span style="font-size: 120%; color: rgb(129, 4, 4)">share ** the burden.
Picture: http://www.flickr.com/photos/thedailyhamster/2416262874/

Elasticity and Tax incidence

"A tax burden will fall more heavily **<span style="font-size: 130%; color: rgb(0, 47, 255)">on which side? **"
A tax burden will fall more heavily depending on the elasticity of supply and demand. In other words, the market that is <span style="font-size: 130%; color: rgb(255, 0, 48)">less elastic will have bear <span style="font-size: 120%; color: rgb(203, 26, 59)">more of the burden of the tax. Take a look at the two graphs below:

When the supply curve is elastic, while the <span style="font-size: 120%; color: rgb(178, 21, 21)">demand curve is inelastic , the tax will fall more heavily on <span style="font-size: 120%; color: rgb(218, 101, 43)">consumers.

So as it is shown on the graph below, the price paid by the buyers rises <span style="font-size: 110%; font-family: 'Lucida Console',Monaco,monospace; color: rgb(6, 0, 255)">greatly compared to the price received by sellers that decreases slightly.

When the demand curve is elastic, while the <span style="font-size: 120%; color: rgb(178, 21, 21)">supply curve is inelastic , the tax will fall more heavily on <span style="font-size: 130%; color: rgb(200, 74, 14)">sellers <span style="font-size: 120%; color: rgb(218, 101, 43)">.

So as it is shown on the graph below, the price received by sellers falls <span style="font-size: 110%; font-family: 'Lucida Console',Monaco,monospace; color: rgb(6, 0, 255)">greatly compared to the price paid by buyers that increases only slightly.

<span style="font-size: 140%; font-family: 'Trebuchet MS',Helvetica,sans-serif"> Looking Back ... <span style="font-size: 140%; color: rgb(204, 0, 0)">Price controls are placed if the policy makers think that the market price of a good is <span style="font-size: 120%; color: rgb(4, 0, 255)">unfair to either the buyers or to the sellers.
 * Price ceiling is the __ maximum __ price of a good
 * Price Floor is the __ minimum __ price of a good

<span style="font-size: 120%; color: rgb(56, 158, 21)">Price ceiling has two possible outcomes
 * equilibrium price is below the ceiling = "not binding"
 * equilibrium price is above the ceiling = "binding constraint" on the market, which results in a shortage

<span style="font-size: 120%; color: rgb(72, 19, 190)">Price floor also has two possible outcomes
 * equilibrium price is higher than the price floor = "not binding"
 * equilibrium price is lower than the price floor = "binding constraint", which results in a surplus

Levying <span style="font-size: 140%; color: rgb(238, 27, 161)">tax on buyers or consumers does not matter because they will share the burden anyway

<span style="font-size: 140%; color: rgb(77, 236, 70)">Tax burden will fall more heavily depending on the elasticity of supply and demand
 * Supply/Demand curve that is less elastic will bear most of the burden of the tax

<span style="font-family: Arial,Helvetica,sans-serif"><span style="color: rgb(239, 31, 31)">Problems and Applications  **<span style="font-family: Arial,Helvetica,sans-serif"><span style="font-size: 140%; font-family: 'Courier New',Courier,monospace">  <span style="font-size: 140%; font-family: 'Courier New',Courier,monospace"><span style="font-size: 80%; font-family: Arial,Helvetica,sans-serif"> Q1. The president of Chaeri’s economic advisers, Mr.Ski persuades Chaeri to impose <span style="font-size: 120%; color: rgb(255, 72, 0)">a binding price floor in the orange market. Draw a supply and demand diagram to show such effect. Show what happens to the price of oranges and the quantity of oranges sold. Is there a **shortage** or **surplus** of oranges? <span style="font-size: 140%; font-family: 'Courier New',Courier,monospace"><span style="color: rgb(176, 166, 7)"><span style="font-size: 80%; font-family: Arial,Helvetica,sans-serif">Answer: <span style="font-size: 140%; font-family: 'Courier New',Courier,monospace"> <span style="font-size: 140%; font-family: 'Courier New',Courier,monospace"> <span style="font-size: 110%; font-family: 'Courier New',Courier,monospace">
 * <span style="font-size: 140%; font-family: 'Courier New',Courier,monospace">

<span style="font-family: Arial,Helvetica,sans-serif; color: rgb(255, 0, 148)">

2. How will the burden of a tax be divided if the supply curve was elastic, but demand curve being inelastic?

__Answer__: Since it has stated in the question that the demand curve is inelastic, the buyers will get most of the burden compared to the sellers. Thus, the price paid by buyers will rise greatly. (Refer to the graph above in the category of when demand curve is "inelastic" <span style="font-size: 110%; font-family: 'Courier New',Courier,monospace">