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CHAPTER
6
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PRINCIPLES
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Teaching Notes
for Each Slide
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
2
Every slide comes with
Explanations and teaching
Tips for the instructor
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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Teaching Notes for
each slide
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
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SUPPLY, DEMAND, AND GOVERNMENT POLICIES
5
EXAMPLE 2: The Market for Unskilled Labor
Wage
paid to
unskilled
workers
Eq’m w/o
price
controls
W
S
$4
Walk-Throughs of
a Number of
Complete
Examples for the
Chapter500
D
L
Quantity of
unskilled workers
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
6
How Price Floors Affect Market Outcomes
A price floor
below the
eq’m price is
not binding –
has no effect
on the market
outcome.
W
S
$4
Price
floor
$3
D
500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
L
7
How Price Floors Affect Market Outcomes
The eq’m wage ($4)
is below the floor
and therefore
illegal.
The floor
is a binding
constraint
on the wage,
causes a
surplus (i.e.,
unemployment).
W
labor
surplus S
Price
floor
$5
$4
D
400
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
550
L
8
The Minimum Wage
Min wage laws
do not affect
highly skilled
workers.
They do affect
teen workers.
Studies:
A 10% increase
in the min wage
raises teen
unemployment
by 1-3%.
W
unemployment S
Min.
wage
$5
$4
D
400
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
550
L
9
ACTIVE LEARNING
Price controls
P
140
Determine
effects of:
1
The market for
hotel rooms
130
S
120
110
A. $90 price Active
100 Learning PowerPoints
ceiling
Allow
90 you to get students
B. $90 price
floor
C. $120 price
floor
engaged
in class by asking
80
them questions and
70
demonstrating
the results
D
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
10
ACTIVE LEARNING
1
A. $90 price ceiling
The price
falls to $90.
P
140
The market for
hotel rooms
S
130
120
Buyers
demand
120 rooms,
sellers supply
90, leaving a
shortage.
110
100
90
80
Price ceiling
D
shortage = 30
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
11
ACTIVE LEARNING
B. $90 price floor
Eq’m price is
above the floor,
so floor is not
binding.
P = $100,
Q = 100 rooms.
P
140
1
The market for
hotel rooms
130
S
120
110
100
90
80
Price floor
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
12
ACTIVE LEARNING
C. $120 price floor
The price
rises to $120.
Buyers
demand
60 rooms,
sellers supply
120, causing a
surplus.
P
140
130
120
110
1
The market for
hotel rooms
surplus = 60
S
Price floor
100
90
80
D
70
60
50
40
0
Q
50 60 70 80 90 100 110 120 130
13
Evaluating Price Controls
 Recall one of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
 Prices are the signals that guide the allocation of
society’s resources. This allocation is altered
when policymakers restrict prices.
 Price controls often intended to help the poor,
but often hurt more than help.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
14
EXAMPLE 3: The Market for Pizza
Eq’m
w/o tax
P
S1
$10.00
The Next Few Slides
will show you the
walk through of a
complete example
D1
500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
15
A Tax on Buyers
The
price
buyers
pay
Hence,
a tax
on buyers
is
nowthe
$1.50
higher
than
shifts
D curve
down
the
market
price
by the
amount
ofP.
the tax.
Effects of a $1.50 per
unit tax on buyers
P
P would have to fall
by $1.50 to make
$10.00
buyers willing
to buy same Q
as before.
$8.50
E.g., if P falls
from $10.00 to $8.50,
buyers still willing to
purchase 500 pizzas.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
S1
Tax
D1
D2
500
Q
16
A Tax on Buyers
New eq’m:
Effects of a $1.50 per
unit tax on buyers
Q = 450
Sellers
receive
PS = $9.50
Buyers pay
PB = $11.00
P
PB = $11.00
S1
Tax
$10.00
PS = $9.50
Difference
between them
= $1.50 = tax
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
D1
D2
450 500
Q
17
The Incidence of a Tax:
how the burden of a tax is shared among
market participants
In our
example,
buyers pay
$1.00 more,
P
PB = $11.00
S1
Tax
$10.00
PS = $9.50
sellers get
$0.50 less.
D1
D2
450 500
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Q
18
A Tax on Sellers
The tax effectively raises
sellers’ costs by
P
$1.50 per pizza.
$11.50
Sellers will supply
500 pizzas
only if
P rises to $11.50,
to compensate for
this cost increase.
Effects of a $1.50 per
unit tax on sellers
S2
Tax S1
$10.00
Hence, a tax on sellers shifts the
S curve up by the amount of the tax.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
D1
500
Q
19
A Tax on Sellers
New eq’m:
Effects of a $1.50 per
unit tax on sellers
Q = 450
Buyers pay
PB = $11.00
Sellers
receive
PS = $9.50
P
PB = $11.00
S2
S1
Tax
$10.00
PS = $9.50
Difference
between them
= $1.50 = tax
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
D1
450 500
Q
20
The Outcome Is the Same in Both Cases!
The effects on P and Q, and the tax incidence are the
same whether the tax is imposed on buyers or sellers!
What matters
is this:
A tax drives
a wedge
between the
price buyers
pay and the
price sellers
receive.
P
PB = $11.00
S1
Tax
$10.00
PS = $9.50
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
D1
450 500
Q
21
CASE STUDY: Who Pays the Luxury Tax?
 1990: Congress adopted a luxury tax on yachts,
private airplanes, furs, expensive cars, etc.
Walk Through a
 Goal of the tax: raise
revenue
from
those
Case Study
who could most easily afford to pay –
wealthy consumers.
 But who really pays this tax?
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
22
CASE STUDY: Who Pays the Luxury Tax?
The market for yachts
P
Buyers’ share
of tax burden
Demand is
price-elastic.
S
In the short run,
supply is inelastic.
PB
Tax
Sellers’ share
of tax burden
PS
D
Q
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
Hence,
companies
that build
yachts pay
most of
the tax.
23
CONCLUSION: Government Policies and
the Allocation of Resources
 Each of the policies in this chapter affects the
allocation of society’s resources.
 Example 1: A tax on pizza reduces eq’m Q.
With less production of pizza, resources
(workers, ovens, cheese) will become available
to other industries.
 Example 2: A binding minimum wage causes
a surplus of workers, a waste of resources.
 So, it’s important for policymakers to apply such
policies very carefully.
SUPPLY, DEMAND, AND GOVERNMENT POLICIES
24
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