Chapter+6+-+Micro

=__**Chapter 6 - Supply, Demand, and Government Policies**__=

As the name of the title dictates, this chapter focuses mainly on government policies, and how economists use the laws of supply and demand to help them advise the government and its policies.

**Controls on Prices**
One of the main policies that the government can make are called price controls. So how do they affect the market price?

Let's use an example. Let's say that I am an ice cream seller. The equilibrium price for a video game is $3 per ice cream. At this quantity and price, I am selling the exact number that buyers (consumers or customers, whatever you want to call them) are demanding. But let's also say that a group, called the Ice Cream Addicts (ICA), is complaining that the $3 per cone price is too high, since they eat one cone of ice cream per day. Conversely, a group called Mothers Against Ice-Cream Eaters (MAICE), complains that they have scientific proof that ice cream induces cancer, and are complaining that the $3 per cone price is too low.

They both lobby the government to see what they can do. If it wasn't already obvious, both of the groups are basically fighting against each other.

What can the government do?

Well, basically they have two options. Well three actually. One is a **price ceiling**, which basically imposes a maximum price of a good, which in this case would be a video game. The second possible option would be a **price floor**, which is, as titled, a minimum price of a good. Let's explore the two...

**Price Ceilings**
As stated before, price ceilings are when a government sets a maximum price for a good. Now let's look at two types of price ceilings:

[[image:Photo_1.jpg align="center"]]
On the left, you can see a price ceiling in a supply and demand curve, which is portrayed as a horizontal straight line. In this case, the price ceiling is $4, and since the equilibrium price is $3 and since I am selling the ice cream for $3, the price ceiling has no effect on my sales. This is called a //non-binding price ceiling.// I am still selling the same price and quantity as before the price ceiling.

However, on the right, it's a bit more complicated. If the government issued a $2 price ceiling, things would get a bit hairy. Because I would have to lower my price from $3 to $2, there would be a shortage. As you can see on the x-axis, the new Quantity supplied would be 75, and the new Quantity Demanded would be 125. That means that for every 125 who want my ice cream, I would only be able to give 75 cones of ice cream.

What would this mean?

There would be a different way and manner in which I would have to allocate my available ice cream. There could be long lines, and a wait for the ice cream, since I can't get ice cream to everyone. Or I could personally give people I know, such as family and friends, ice cream before other potential customers.

In conclusion, price ceilings shrink the size of the market, and make the consumers unhappy. If you go back to the original intent of a price ceiling, it was to make the buyers happy by decreasing the price. However, it has made the consumers unhappy. Long lines are inefficient, and waste everyone's time. And selling ice cream to people that I want to sell it to (friends/family) would be unfair to other customers. Furthermore, my revenue would take a sharp decrease (remember, revenue is Price times Quantity). Before the ceiling, the revenue was 300 dollars. But, after the ceiling, my revenue would become 150 dollars, half the original revenue.

As a result, due to a price ceiling, the market could shrink drastically, and lead to unhappy consumers and suppliers.

**Price Floors**
As stated before (if you already forgot), price floors are a legal minimum price a good can be, the opposite of a price ceiling.



Again, for price floors, there are price floors that are binding and ones that are non-binding. The supply and demand diagram on the left is an example that is //non-binding//. Remember my equilibrium price is $3, but if the government decides that the least I could sell my ice cream is $2, then it wouldn't make any difference, so it would be non-binding.

However, if the government decides to make the price floor $4, then I would have to sell my ice cream for $4 minimum. This would distort my sales because it diverts me from selling my ice cream in equilibrium price. Thus, if you look at the diagram on the right, it would be called a //binding// price floor. The new Quantity Supplied would be 120, and the new Quantity Demanded would be 80. Thus, since there would be only 80 customers for every 120 ice creams that I make, there would be a shortage.

Here's a brief video about price floors and minimum wage:

media type="youtube" key="F6wJVCnRP8s" height="344" width="425"

- markets should be left alone to maximize efficiency - the government and its policies sometimes make the market less efficient, but more equitable (fair) - governments can impose price ceilings or price floors, maximum prices and minimum costs respectively, in order to implements its policies - if a price ceiling or price floor is non-binding, it doesn't affect or distort the equilibrium price or quantity - however, if a price ceiling or price floor is binding, then it messes up and changes the price and quantity to something that is not of equilibrium price - but sometimes this distortion of equilibrium can be good, depending on your point of view
 * Summary**

TAXES
Government tax people to use the revenue for public projects. When the government levies a tax on a certain good, who bears the burden? Suppliers or buyers? What determines how the burden is divided? The distribution of a tax burden is called tax incidence.

How Taxes on Buyers Affect Market Outcomes
How does taxes on buyers affect the buyers and sellers in the market? To answer this, we can follow 3 steps. 1) Decide whether the supply curve or demand curve is affected. 2) Decide which way the curve shifts. 3) Compare with the original equilibrium.

STEP ONE- The demand curve is affected because buyers now have to pay more money per good. STEP TWO- The demand curve shifts downward because buyers demand smaller quantity of the good at every price. STEP THREE- Since the demand curve shifts downward, as you can see from the new equilibrium, sellers sell less and buyers buy less. The market size reduces. Buyers and sellers share the burden of taxes.

How Taxes on Sellers Affect Market Outcomes
How does taxes on sellers affect the buyers and sellers in the market? Again, we follow 3 steps. STEP ONE- The supply curve is affected because sellers now receive less money per good. STEP TWO- The supply curve shifts to the left because sellers supply smaller quantity of the good at every price. STEP THREE- Since the supply decreases, as you can see from the new equilibrium, sellers sell less and buyers buy less. The market size reduces. Buyers and sellers share the burden of taxes.



Regardless of whether the tax is levied on buyers or sellers, they share the burden of the tax. The only difference is who sends the money to the government.

Elasticity and Tax Incidence
We just learned that buyers and sellers share the burden of the tax. But how exactly is the tax burden divided? It depends on the elasticity of the demand curve and supply curve. A tax burden falls more heavily on the side of the market that is less elastic. This is true because the elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable. Small elasticity, therefore, means it is hard to leave the market despite the tax.

__**Conclusion**__ Many economists usually oppose government policies such as price floors and price ceilings. Remember, economists have two jobs: they experiment, and find new economical trends, but they also are policy advisors. In their argument against price floors and ceilings, their main argument that a price of a good is the result of millions of consumers and suppliers. The price of a good is not an accident. Therefore, we should leave prices as they are.

However, efficiency and the ability to sell goods at the optimum price is not the only concern for governments. Governments must also keep in mind the poor, and must alter market conditions to help them. Though they sometimes don't utilize the best choice, some of the choices that governments make are essential for a more equitable society.

__Glossary__ price ceiling - a legal maximum price at which a good can be sold price floor - a legal minimum price at which a good can be sold tax incidence - allocation of tax burden among buyers and sellers

__**Questions**__
1. What is a price ceiling? Price floor? 2. What is the difference of a binding and a non-binding price ceiling? 3. What are some good things about government policies? Bad things?

Answer with "price ceiling" or "price floor" 4. A government would impose a _ if they wanted to help the consumers of a good by making a minimum limit in which the good's sellers could sell the good. 5. A government would impose a _ if they wanted to help the sellers of a good make more money by imposing a maximum limit in which a good can be sold.

__**Answers**__
1. Price ceiling is the legal maximum in which a good can be sold. A price floor is the legal minimum in which a price can be sold. 2. A binding price ceiling causes a shortage, while a non-binding price ceiling doesn't make a difference in the supply and demand curve. 3. Some good things about government policies include more equity for the people, while not having government policies would make the market more efficient, but not helpful to poorer people. 4. Price floor. 5. Price ceiling.