Business Finance - Accounting assignment/ discussion

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Mankiw_PrinciplesOfEconomics_10e_PPT_CH06.pptx

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Principles of Economics, 10e

Chapter 6: Supply, Demand, and Government Policies

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Chapter Objectives (1 of 2)

By the end of this chapter, you should be able to:

Determine the impact of price controls on economic welfare using the supply and demand model.

Determine if a price control is a price ceiling or a price floor using the supply and demand model.

Determine if a price control is binding using the supply and demand model.

Determine the amount of shortage or surplus generated by a price control using the supply and demand model.

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Chapter Objectives (2 of 2)

Describe the unintended consequences of rent control using the supply and demand model.

Explain how a change in a labor supply determinant impacts labor supply.

Identify the tax incidence on consumers and producers for a given market.

Determine the impact of a tax on the equilibrium price and quantity in a market.

Analyze the relationship between elasticity and tax burden.

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6-1

The Surprising Effects of Price Controls

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Price Controls

Economists as policy analysts and advisers try to use theories to change the world

Policymakers often enact price controls when they believe that the market price of a good or service is too high or too low

These policies can generate problems of their own

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Price Ceiling and Price Floor

Price ceiling*

A legal maximum on the price at which a good can be sold

Rent-control laws

Price floor*

A legal minimum on the price at which a good can be sold

Minimum wage laws

*Words accompanied by an asterisk are key terms from the chapter.

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How Price Ceilings Affect Market Outcomes

Not binding

Set above the equilibrium price

No effect on price or quantity sold

Binding constraint

Set below the equilibrium price

Market price must be the price ceiling

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Active Learning 1: Price Ceilings for Muffins

The Muffin Buyers’ Association lobbies the government to impose a price ceiling. Which of the following is binding and what’s the effect on the market?

The price ceiling is set at $5

The price ceiling is set at $2

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Allow your students 5–10 minutes to work by themselves or in groups before asking for volunteers to share their answers. The correct answers are on the next slide.

Remind your students that a price ceiling is a maximum legal price (so any prices below the price ceiling are fine, but prices above the ceiling are not possible/legal).

Active Learning 1: Answers

The price ceiling is set at $5

Not binding

P = $3, Q = 15

The price ceiling is set at $2

Binding

P = $2, Qd = 18, Qs = 10

Shortage = 8 muffins

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Allow your students 5–10 minutes to work by themselves or in groups before asking for volunteers to share their answers. The correct answers are on the next slide.

A price ceiling is a maximum legal price, so prices set above the ceiling will not be legal.

If the price ceiling is set at $5, above the equilibrium price, there’s no impediment to the market reaching the equilibrium (well, staying in equilibrium at P = $3). Sellers continue to sell muffins at $3 each, and 15 muffins are sold and bought.

If the price ceiling is set at $2 (at the request of the “buyers’ association” of “Oh, no, muffins are too expensive, and the government should do something about the very expensive muffins!!”). Because it is below the market equilibrium, the $2 price ceiling is binding and it will keep the market in disequilibrium: shortage of muffins!! Though the buyers requested and got the lower prices, buyers will not be able to buy the 15 equilibrium muffins, but they will have to be happy with the 10 muffins sellers will be willing and able to sell at the lower price. Yikes!

Figure 1 A Market with a Price Ceiling

In panel (a), the government imposes a price ceiling of $4. Because it is above the equilibrium price of $3, the ceiling has no effect, and the market can reach the equilibrium of supply and demand. At this point, quantity supplied and quantity demanded both equal 100 cones. In panel (b), the government imposes a price ceiling of $2. Because the ceiling is below the equilibrium price of $3, the market price is $2. At this price, 125 cones are demanded while only 75 are supplied, so there is a shortage of 50 cones.

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Binding Price Ceiling

When the government imposes a binding price ceiling

Shortage arises

Sellers must ration scarce goods among potential buyers

Rationing mechanisms are rarely desirable

Long lines waste buyers’ time

Bias of sellers

Inefficient (good may not go to the buyer who values it most)

Unfair

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Rationing Mechanism

Rationing mechanism in a free, competitive market is straightforward

When market reaches its equilibrium, anyone who wants to pay the market price can buy the good

May seem unfair to some buyers when prices are high

Is efficient and impersonal

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Figure 2 The Market for Gasoline with a Price Ceiling

Panel (a) shows the gasoline market when the price ceiling is not binding because the equilibrium price, P1, is below the ceiling. Panel (b) shows the gasoline market after an increase in the price of crude oil (an input into making gasoline) shifts the supply curve to the left from S1 to S2. In an unregulated market, the price would have risen from P1 to P2. The price ceiling, however, prevents this from happening. At the binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS. The difference between quantity demanded and quantity supplied, QD - QS, measures the gasoline shortage.

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Ask the Experts: Rent Control

“Local ordinances that limit rent increases for some rental housing units, such as in New York and San Francisco, have had a positive impact over the past three decades on the amount and quality of broadly affordable rental housing in cities that have used them.”

Source: IGM Economic Experts Panel, February 7, 2012.

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This “Ask the Experts” feature provides the opportunity for class discussion. If you want, you can move this feature and class discussion after you have presented the rent control example on the next slide.

Start by asking the class what they know about rent control (you may have to explain what rent control is, and tell them that the main goal of this policy is to help the poor by making housing more affordable).

After showing the statement, you can ask your students to choose one of the options: agree, disagree, or uncertain. You can collect their answers in a variety of ways: show of hands, ballot, clicker system, etc. If time permits, you can allow students to group together and discuss some of the reasons of why they chose their answer.

Ask the students to share with the class their reasons. Their answers will vary.

Figure 3 Rent Control in the Short Run and in the Long Run

Panel (a) shows the short-run effects of rent control: Because the supply and demand curves for apartments are relatively inelastic, the price ceiling imposed by a rent-control law causes only a small shortage of housing. Panel (b) shows the long-run effects of rent control: Because the supply and demand curves for apartments are more elastic, rent control causes a larger shortage.

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How Price Floors Affect Market Outcomes

Not binding

Set below the equilibrium price

No effect on price or quantity sold

Binding constraint

Set above the equilibrium price

Some sellers are unable to sell what they want

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Binding Price Floor

When the government imposes a binding price ceiling

Surpluses arise

Sellers who appeal to the buyers’ personal biases may be better able to sell their goods than those who do not

In a free market, price is the rationing mechanism

Sellers may not be happy about how much they are paid at the equilibrium price, but they can sell all they want

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Figure 4 A Market with a Price Floor

In panel (a), the government imposes a price floor of $2. Because it is below the equilibrium price of $3, the floor has no effect, and the market can reach the equilibrium of supply and demand. At this point, quantity supplied and demanded both equal100 cones. In panel (b), the government imposes a price floor of $4. Because the floor is above the equilibrium price of $3, the market price is $4. At this price, 120 cones are supplied while only 80 are demanded, so there is a surplus of 40 cones.

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Ask the Experts: The Minimum Wage

“The current US federal minimum wage is $7.25 per hour. States can choose whether to have a higher minimum—and many do. A federal minimum wage of $15 per hour would lower employment for low-wage workers in many states.”

Source: IGM Economic Experts Panel, February 2, 2021.

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This “Ask the Experts” feature provides the opportunity for class discussion.

I think this feature is better suited here, after the discussion of minimum wage as a binding price floor.

After showing the statement, you can ask your students to choose one of the options: agree, disagree, or uncertain. You can collect their answers in a variety of ways: show of hands, ballot, clicker system, etc. If time permits, you can allow students to group and discuss some of the reasons they chose their answer.

Ask the students to share with the class their reasons. Their answers will vary.

On the next slide, we see some things from the minimum wage case study in the text that are worth mentioning to explain why economists disagree on this issue.

Figure 5 How the Minimum Wage Affects a Competitive Labor Market

Panel (a) shows a labor market in which the wage adjusts to balance labor supply and labor demand. Panel (b) shows the impact of a binding minimum wage. Because the minimum wage is a price floor, it causes a surplus: The quantity of labor supplied exceeds the quantity demanded. The result is unemployment.

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Active Learning 2: Price Floors for Muffins

The Muffin Buyers’ Association lobbies the government to impose a price floor. Which of the following is binding and what’s the effect on the market?

The price floor is set at $1

The price ceiling is set at $4

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Allow your students 5–10 minutes to work by themselves or in groups before asking for volunteers to share their answers. The correct answers are on the next slide.

Remind your students that a price floor is a minimum legal price (so any prices above the price floor are fine, but prices below the floor are not possible/legal).

Active Learning 2: Answers

The price floor is set at $1

Not binding

P = $3, Q = 15

The price floor is set at $4

Binding

P = $4, Qd = 12, Qs = 20

Surplus = 8 muffins

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A price floor is a minimum legal price, so prices set below the floor will not be legal.

If the price floor is set at $1, below the equilibrium price, there’s no impediment to the market reaching the equilibrium (well, staying in equilibrium at P = $3). Sellers continue to sell muffins at $3 each, and 15 muffins are sold and bought.

If the price floor is set at $4 (at the request of the “sellers’ association” of “Oh, no, muffins are too cheap and we’re not making enough money, and the government should do something about the very cheap muffins!!”), because it is above the market equilibrium, the $4 price floor is binding, and it will keep the market in disequilibrium: surplus of muffins!! Though the sellers requested and got the higher prices, sellers will not be able to sell the 15 equilibrium muffins, but they will have to be happy with the 12 muffins the buyers will be willing and able to buy at the higher price. Yikes!

Evaluating Price Controls (1 of 2)

Markets are usually a good way to organize economic activity

Prices balance supply and demand

Price-setting obscures signals that guide the allocation of society’s resources

Governments can sometimes improve market outcomes

Motivated to control prices

View the market’s outcome as unfair

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Evaluating Price Controls (2 of 2)

Price controls can hurt some people they are intended to help

Alternative policies are often better

Rent subsidy

Wage subsidy (earned income tax credit)

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6-2

The Surprising Study of Tax Incidence

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Taxes

Governments use taxes to raise revenue for public projects

Tax incidence*

Manner in which the burden of a tax is shared among participants in a market

*Words accompanied by an asterisk are key terms from the chapter.

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How Taxes on Sellers Affect Market Outcomes

Taxes discourage market activity

Quantity sold is smaller in the new equilibrium

Buyers and sellers share the tax burden

Buyers pay more, and sellers receive less

Sellers send the money to the government

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Figure 6 A Tax on Sellers

When a tax of $0.50 is levied on sellers, the supply curve shifts up by $0.50 from S1 to S2.

The equilibrium quantity falls from 100 to 90 cones.

The price that buyers pay rises from $3.00 to $3.30.

The price that sellers receive (after paying the tax) falls from $3.00 to $2.80.

Even though sellers are legally responsible for paying the tax, buyers and sellers share the burden.

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How Taxes on Buyers Affect Market Outcomes

Taxes discourage market activity

Quantity sold is smaller in the new equilibrium

Buyers and sellers share the tax burden

Buyers pay more, and sellers receive less

Buyers pay a lower market price but effective price (with tax) rises

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Figure 7 A Tax on Buyers

When a tax of $0.50 is imposed on buyers, the demand curve shifts down by $0.50 from D1 to D2.

The equilibrium quantity falls from 100 to 90 cones.

The price that sellers receive falls from $3.00 to $2.80.

The price that buyers pay (including the tax) rises from $3.00 to $3.30.

Even though buyers are legally responsible for paying the tax, buyers and sellers share the burden.

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Tax Incidence

Taxes on sellers and taxes on buyers are equivalent

The tax

Inserts a wedge between price that buyers pay and price that sellers receive

Shifts the relative position of the supply and demand curves

Buyers and sellers share the tax burden in the new equilibrium

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Figure 8 A Payroll Tax

A payroll tax places a wedge between what firms pay and what workers receive.

Comparing wages with and without the tax makes it clear that workers and firms share the tax burden.

This division does not depend on whether the government imposes the tax entirely on workers, imposes it entirely on firms, or divides it equally between the two groups.

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Elasticity and Tax Incidence (1 of 2)

Tax burden falls more heavily on the side of the market that is less elastic

Elasticity measures the willingness of buyers or sellers to leave the market when conditions worsen

A small elasticity of demand means that buyers do not have good alternatives to consuming this particular good

A small elasticity of supply means that sellers do not have good alternatives to producing this particular good

The side of the market less willing to leave the market bears more of the burden of the tax

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Elasticity and Tax Incidence (2 of 2)

Elastic supply, inelastic demand

Price received by sellers does not fall much

Price paid by buyers rises substantially

Buyers bear most of the tax burden

Inelastic supply, elastic demand

Price paid by buyers does not rise much

Price received by sellers falls substantially

Sellers bear most of the tax burden

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Figure 9 How a Tax Burden Is Divided (1 of 2)

In panel (a), the supply curve is elastic, and the demand curve is inelastic.

In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially. This means that buyers bear most of the tax burden.

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Figure 9 How a Tax Burden Is Divided (2 of 2)

In panel (b), the situation is reversed: The supply curve is inelastic, and the demand curve is elastic.

In this case, the price received by sellers falls substantially, while the price paid by buyers rises only slightly. Here, sellers bear most of the burden.

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6-3

Conclusion

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Conclusion

Price controls and taxes are common in various markets, and their effects are frequently debated

When analyzing government policies, supply and demand are the first and most useful tools of analysis

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Think-Pair-Share Activity

Suppose that your state needs to raise more tax revenue. The governor proposes a tax on food because everyone must eat and, thus, a food tax would surely raise a great deal of tax revenue. The governor insists the tax should be placed on food sellers to protect less wealthy individuals who spend a large proportion of their income on food.

Will the burden of a food tax fall only on the sellers of food as the governor said? Explain.

Who will bear most of this tax burden? Explain.

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Suggestion: For the Think-Pair-Share activities, if time allows, allow students to work in small groups for 5–10 minutes. Then allow student groups to share with other groups or with the entire class. Or, you can treat the Think-Pair-Share activity as an open-to-all in class discussion.

Discussion points:

A. No. Both sides of the market will be affected by a tax on food, regardless of what the law says. The effects of this tax will be: lower Q (quantity of food bought and sold), higher PB (buyers pay a higher price for food), lower Ps (sellers receive a lower price for food).

B. The tax burden is determined by the elasticity of supply and demand. The burden of a tax falls most heavily on the side of the market that is less elastic. That is, the burden is on the side of the market least willing to leave the market when the price moves unfavorably. The burden will fall most heavily on the buyers of food regardless of whether the tax is legally imposed on buyers or on sellers. Food is a necessity, and therefore the demand for food is relatively inelastic. When the price rises due to the tax, people still must eat. Grocery chains can sell another product line when the price they receive for food falls due to the tax.

Self-Assessment

What determines how the burden of a tax is divided between buyers and sellers? Why?

When the government levies a tax on the amount that firms pay their workers, do the firms or workers bear the burden of the tax?

Business Finance - Accounting assignment/ discussion

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