Chapter 4
Supply and Demand:
Applications and Extensions
1
Overview
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The resource market (particularly the
labor market)
Price Controls: price floors and ceilings
(surpluses and shortages)
Impact of a tax
The tax system
The Laffer curve
Subsidies
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The Labor Market
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Price for labor is called the wage (W)
Quantity of labor is called employment (E)
*Note: works just like the market for
goods, only with a different name for price
(wage) and quantity (employment)
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Labor Demand
1. Firms demand labor
2. Labor demand curve is downward
sloping because as wage decreases,
firms will want to employ more people
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Changes in Labor Demand
1. An increase in labor demand (labor
demand shifts right)
2. A decrease in labor demand (labor
demand curve shifts left)
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Labor Supply
1. Workers supply labor
2. Labor supply curve is upward sloping
because as wage increases, people will
want to work more.
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Changes in Labor Supply
1. Increase in labor supply: (labor supply
curve shifts right)
2. Decrease in labor supply: (labor supply
curve shifts left)
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Linking the Markets
There is a close relationship between the
demand for products and the demand for
resources used to make those products
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Linking the Markets
when the demand for a product changes,
the demand for the resources used to
produce it will change in the same
direction
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Price Floor
Price floor: A legally established minimum
price buyers must pay for a good or
resource
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A price floor above equilibrium price
creates a surplus
A price floor below equilibrium price does
nothing
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Surplus
Surplus: A condition in which the amount
offered for sale is greater than the amount
that buyers will purchase at existing
prices.
Also known as excess supply:
Quantity supplied > Quantity demanded
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Application: Minimum Wage
The minimum wage is an example of a price
floor.
Raising minimum wage increases excess
labor supply (unemployment).
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Price Ceiling
Price ceiling: A legally established
maximum price sellers can charge for a
good or resource
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A price ceiling below market equilibrium
price creates a shortage
A price ceiling above market equilibrium
price does nothing
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Shortage
Shortage: a condition in which the amount
offered for sale is less than the amount
demanded by buyers at existing prices
Also known as excess demand:
Quantity demanded > Quantity supplied
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Application: Disaster Markets
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Application: Rent Control
Rent controls lead to shortages as well as:
1.
2.
3.
4.
5.
Black markets
A decline in the supply of future rental
housing
A decline in quality of rental housing
Non-price methods of rationing
Inefficient housing match-ups
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Impact of a Tax
A tax on a product will cause the supply curve to
shift left by the amount of the tax.
1.
2.
3.
4.
5.
Raises the price that buyers pay
Reduces the amount sellers receive
Reduces the quantity sold
Increases government revenue
Creates deadweight loss
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Deadweight loss
The loss to society that results from the loss
of gains to trade that does not occur
because a tax was imposed.
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Tax Incidence
Tax Incidence: The way the burden of a
tax is distributed among economic units
(also known as the tax burden)
It does not depend on whom the tax is
imposed.
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Tax Incidence
Tax incidence does depend on elasticity:
The burden of the tax will fall on those who
are relatively inelastic.
Deadweight loss will be lower if taxes are
placed on goods that are relatively
inelastic.
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The Tax System
Average tax rate (ATR): the percentage of
income paid in taxes
ATR = tax liability / taxable income
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The Tax System
3 possibilities:
1. Progressive tax: average tax rate rises with
income
2. Regressive tax: average tax rate falls with
income
3. Proportional tax: average tax rate is the same at
all income levels
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The Tax System
Marginal tax rate (MTR): The additional
tax liability a person faces divided by his
or her additional taxable income.
MTR = change in tax liability / change
in taxable income
*Note: Marginal tax rates are what is
important in personal decision making.
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Fairness and Efficiency
1.
2.
Is the progressive tax system
economically efficient?
Is the progressive tax system fair?
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The Laffer Curve
The Laffer Curve: A curve illustrating the
relationship between the tax rate and tax
revenue.
Higher tax rates will not always lead to more
tax revenue!!
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Subsidies
Subsidy: A payment the government
makes to either the buyer or seller when a
good or service is purchased or sold.
ex. Subsidizing treadmills
*Note: Subsidies are costly
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Farm Subsidies
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Review
1. Why is labor demand downward sloping?
2. Why is labor supply upward sloping?
3. What is the effect of a price ceiling (price
floor)?
4. What is the impact of a tax?
5. Calculate average tax rate and marginal tax
rate.
6. Understand the Laffer Curve.
7. Understand the impacts of a subsidy
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