Chapter+6+Kathy+L

   

 How do government policies affect the supply and demand?

 This chapter is where we first look into policy. We get to peek into how government impacts supply and demand. Sometimes, surprisingly, policies may bring consequences that were not intended or anticipated.

First, we will look at how some policies may control prices. Price controls are imposed mostly when policymakers think that the market price of a good or service seems unfair to the buyers or sellers. However, although it seems like these policies will bring only positive effects, this is not always the case. Throughout the lecture, cases when government policies are not as efficient will be introduced.

Next, we will see how taxes work. Why do governments use taxes at all? Well, policymakers suggest taxes to influence market outcomes and to raise revenue for public purpose. What are the affects of taxes? Only positive? Potentially harmful for some? We will further explore this concept in the lecture portion of the textbook.

 There are two main ways prices are controlled by the government: (1) Price Ceiling (2) Price Floor

__Price Ceiling__ Now, when a government sets a price ceiling, it means that a legal maximum is set for a price at which a good can be sold to the consumers. If a price seems unfairly high for the consumers, the government can decide to set this ceiling. What does the price ceiling exactly do?

(a) When the price ceiling is above the equilibrium point, it is said to be **not binding**. This means that the price ceiling has no direct impact on the price or quantity of the good. The forces of the market would just move the supply and demand to equilibrium.

(b) The more interesting result in when the price ceiling is below the equilibrium price. This is when the ceiling is a **binding constraint** on the market. This means that the forces of supply and demand does the same as when the ceiling is not binding--the forces push the supply and demand to equilibrium. However, when the market price hits the price ceiling, it is not allowed to rise any further, and thus at this price ceiling ,the quantity of the good demanded will exceed the quantity supplied. Thus, a //shortage of the good is created//, and some people who would want to buy the good at the going price would be unable to.

Now that we know what price ceilings are, let's examine. ..

__Price Floors__ Price floors just like price ceilings, is an attempt by the government to maintain prices at other than equilibrium levels. A price floor sets the legal minimum price. Just like price ceilings, there can be two outcomes from the price floor.

(a) If the price floor is below the equilibrium, it is considered non-binding. The price floor would have no effect on the price or quantity of the good.

(b) Price floor could also be below the equilibrium. In this case, it is also referred to as binding restraint, but it creates surplus instead of shortage like the price ceiling. The Surplus is created because there is not more quantity supplied than the quantity demanded.

 Tax

Who should the government tax? The buyers or the sellers? Does it matter, really, much at all?

To learn how taxes on **buyers** affect the market outcomes, you must consider: - Whether the law impacts the supply curve or the demand curve - In which way the curve shifts - How the shift affects the equilibrium > <span style="font-family: Verdana,Geneva,sans-serif;">Since taxes discourage market activity, the quantity that is being sold would be smaller in the new equilibrium <span style="font-family: Verdana,Geneva,sans-serif;"><span style="font-family: Verdana,Geneva,sans-serif;"> Buyers and sellers both share the burden of the tax!

To knew how taxes on sellers affect the market outcomes, consider the same factors.

Tax graph with shift in the supply curve

Now you might be wondering, //how do you divide up the tax burden//? It is surely difficult for the tax burden to be equal between the suppliers and demanders.


 * The tax burden falls more heavily on the side that is less elastic.**

Why? Remember what elasticity is? The more elastic a good is, the more it is considered a 'luxury'. For instance, diamonds and iPods are all luxuries--they aren't necessary for your survival. On the other hand, inelastic goods are basic necessities such as water.

> <span style="font-family: Verdana,Geneva,sans-serif;">Elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable > <span style="font-family: Verdana,Geneva,sans-serif;">Inelastic demand means that buyers do not have good alternative to consuming this particular good > <span style="font-family: Verdana,Geneva,sans-serif;">Fewer alternatives cannot easily leave the market, and must bear more for the burden of the tax. <span style="font-family: Verdana,Geneva,sans-serif;"> Sellers would bear more of the burden if there is elastic demand and inelastic supply. Buyers would bear more of the tax burden with inelastic demand and elastic supply.

<span style="font-family: Verdana,Geneva,sans-serif;"> <span style="font-family: Verdana,Geneva,sans-serif;">**Price Ceiling:** a legal maximum on the price at which a good can be sold
 * Price floor:** a legal minimum on the price at which a good can be sold
 * Tax incidence**: the manner in which the burden of a tax is shared among participants in a market.