Supply, Demand, and
Government Policies
(Framboð, eftirspurn
og stefna stjórnvalda)
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6
Supply, Demand, and Government
Policies
• In a free, unregulated (óreglusett) market
system, market forces (kraftar markaðarins)
establish (leggja grunn að) equilibrium prices
and exchange quantities.
• While equilibrium conditions may be efficient,
it may be true that not everyone is satisfied.
• One of the roles of economists is to use their
theories to assist in the development of policies.
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CONTROLS ON PRICES
• Are usually enacted when policymakers believe
the market price is unfair to buyers or sellers.
• Result in government-created price ceilings and
floors.
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CONTROLS ON PRICES
• Price Ceiling (verð þak)
• A legal maximum on the price at which a good can
be sold.
• Price Floor (verð gólf)
• A legal minimum on the price at which a good can
be sold.
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How Price Ceilings Affect Market Outcomes
• Effects of Price Ceilings
• A binding price ceiling creates
• shortages because QD > QS.
• Example: Gasoline shortage of the 1970s
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Figure 2 The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Price of
Gasoline
S2
2. . . . but when
supply falls . . .
S1
P2
Price ceiling
3. . . . the price
ceiling becomes
binding . . .
P1
4. . . .
resulting
in a
shortage.
Demand
0
QS
QD Q1
Quantity of
Gasoline
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The Minimum Wage
• An important example of a price floor (verðgólf) is the
minimum wage (lágmarkslaun). Minimum wage laws
dictate (stýra verðir niður í lægsta mögulega verð) the
lowest price possible for labor that any employer may
pay.
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Figure 5 How the Minimum Wage Affects the Labor Market
Wage
Laun
Labor
Supply
Equilibrium
wage
Labor
demand
0
Equilibrium
employment
Quantity of Magn
Labor vinnuafls
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Figure 5 How the Minimum Wage Affects the Labor Market
Wage
Umframframboð
(atvinnuleysi)
Minimum
wage
Labor
Supply
Labor surplus
(unemployment)
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
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TAXES
• Governments levy taxes (leggja á skatta) to
raise revenue for public projects.
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How Taxes on Buyers (and Sellers) Affect
Market Outcomes Áhrif skatta á markaðinn
• Taxes discourage market activity.
• When a good is taxed, the
quantity sold is smaller.
• Buyers and sellers share
the tax burden.
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Elasticity and Tax Incidence
• Tax incidence (dreifing skattbyrðar) is the
study of who bears the burden of a tax.
• Taxes result in a change in market equilibrium.
• Buyers pay more and sellers receive less,
regardless of whom the tax is levied on.
Copyright © 2004 South-Western/Thomson Learning
Figure 6 A Tax on Buyers
Price of
Ice-Cream
Price
Cone
buyers
pay
$3.30
Price
3.00
2.80
without
tax
Price
sellers
receive
Supply, S1
Equilibrium without tax
Tax ($0.50)
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).
Equilibrium
with tax
D1
D2
0
90
100
Quantity of
Ice-Cream Cones
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Elasticity and Tax Incidence
• What was the impact of tax?
• Taxes discourage market activity.
• When a good is taxed, the quantity sold is smaller.
• Buyers and sellers share the tax burden.
Copyright © 2004 South-Western/Thomson Learning
Figure 7 A Tax on Sellers
Price of
Ice-Cream
Price
Cone
buyers
pay
$3.30
3.00
Price
2.80
without
tax
S2
Equilibrium
with tax
S1
Tax ($0.50)
A tax on sellers
shifts the supply
curve upward
by the amount of
the tax ($0.50).
Equilibrium without tax
Price
sellers
receive
Demand, D1
0
90
100
Quantity of
Ice-Cream Cones
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