N.

GREGORY MANKIW
PRINCIPLES OF

ECONOMICS
Eighth Edition

CHAPTER Supply, Demand,

6 and Government Policies
Premium PowerPoint Slides by:
V. Andreea CHIRITESCU
Eastern Illinois University
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1
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 Look for the answers to these questions:
• What are price ceilings and price floors?
What are some examples of each?
• How do price ceilings and price floors
affect market outcomes?
• How do taxes affect market outcomes?
How do the effects depend on whether
the tax is imposed on buyers or sellers?
• What is the incidence of a tax?
What determines the incidence?
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 Government Policies That Alter the
Private Market Outcome
• Price controls
– Price ceiling: legal maximum on the price
at which a good can be sold
• Rent-control laws
– Price floor: legal minimum on the price at
which a good can be sold
• Minimum wage laws
• Taxes: government can make buyers or
sellers pay a specific amount on each unit
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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.”

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 EXAMPLE 1: The Market for Apartments

Rental P S
price of Equilibrium
apartments without price
$800 controls

D
Q
300
Quantity
of apartments

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 How Price Ceilings Affect Market Outcomes

P S
A price ceiling Price
$1000
above the ceiling
equilibrium price $800
is not
binding—
has no effect on
the market D
outcome. Q
300

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 How Price Ceilings Affect Market Outcomes

The equilibrium
P S
price ($800) is
above the ceiling
and therefore
illegal. $800
The price ceiling Price
is binding, $500
ceiling
causes a shortage
shortage. D
Q
250 400

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 How Price Ceilings Affect Market Outcomes

In the long run,

P S
supply and
demand of rental
apartments are
more price- $800
elastic. Price
$500
ceiling
So, the shortage shortage
is larger. D
Q
150 450

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 8
 Shortages and Rationing
• Because of shortage
– Sellers must ration the goods among
buyers
• Some rationing mechanisms:
• Long lines
• Discrimination according to sellers’ biases
– Are often unfair and inefficient
• The goods do not necessarily go to the
buyers who value them most highly

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 Price Ceiling
• Video:

• https://www.youtube.com/watch?v=RBGH
mCIBr9M

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 10
management system for classroom use.
 EXAMPLE 2: The Market for Unskilled Labor

Wage W S
paid to
unskilled Equilibrium
workers without price
$6.00
controls

D
L
500
Quantity of
unskilled workers

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 How Price Floors Affect Market Outcomes

W S
A price floor
below the
equilibrium price
$6.00
is not binding –
has no effect on Price
$5.00
the market floor
outcome.
D
L
500

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 How Price Floors Affect Market Outcomes

The equilibrium wage ($6) labor

is below the floor and W surplus S
therefore illegal. Price
$7.25
The price floor is binding, floor
causes a surplus (i.e.,
unemployment). $6.00

Minimum wage laws do

not affect highly skilled
workers. They do affect
D
teen workers. A 10% L
increase in the minimum 400 550
wage raises teen
unemployment by 1–3%.
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 ASK THE EXPERTS
The Minimum Wage
“If the federal minimum wage is raised gradually
to $15-per-hour by 2020, the employment rate for
low-wage U.S. workers will be substantially lower
than it would be under the status quo.”

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 Minimum Wage
• https://www.youtube.com/watch?v=65kfA
swiHLk&list=PL-uRhZ_p-
BM4XnKSe3BJa23-
XKJs_k4KY&index=37

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as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 15
management system for classroom use.
 Evaluating Price Controls
• Markets are usually a good way to
organize economic activity
– Economists usually oppose price ceilings
and price floors
– Prices are not the outcome of some
haphazard process
– Prices have the crucial job of balancing
supply and demand
• Coordinating economic activity

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management system for classroom use.
 Evaluating Price Controls
• Governments can sometimes improve
market outcomes
– Want to use price controls
• Because of unfair market outcome
• Aimed at helping the poor
– Often hurt those they are trying to help
– Other ways of helping those in need
• Rent subsidies
• Wage subsidies (earned income tax credit)

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 Taxes
• Government uses taxes
– To raise revenue for public projects
• Roads, schools, and national defense
• Tax incidence
– Manner in which the burden of a tax is
shared among participants in a market
• The government can make the seller or the
buyer to pay the tax

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 EXAMPLE 3: The Market for Pizza

P
S1 Equilibrium
without tax
$10.00

D1

Q
500

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 A Tax on Buyers

Effects of a $1.50 per Hence, a tax on buyers

unit tax on buyers shifts the D curve down by
the amount of the tax.
P
The price buyers pay is now
S1
$1.50 higher than the market
$10.00 price P.
Tax
P would have to fall by $1.50
to make buyers willing to buy
$8.50
D1 same Q as before.
D2 • E.g., if P falls from $10.00
Q to $8.50, buyers are still
500
willing to purchase 500
pizzas.
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 A Tax on Buyers

Effects of a $1.50 per New equilibrium:

unit tax on buyers • Q = 450
P • Sellers receive
PS = $9.50
S1
PB = $11.00
Tax
• Buyers pay PB
$10.00 = $11.00
PS = $9.50 Difference
between them =
D1 $1.50 = tax
D2
Q
450 500

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 The Incidence of a Tax:
how the burden of a tax is shared among
market participants

P
In our
S1
example, PB = $11.00
Tax
buyers pay $10.00
$1.00 more, PS = $9.50
sellers get
$0.50 less. D1
D2
Q
450 500

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 A Tax on Sellers
Effects of a $1.50 per
The tax effectively raises
unit tax on sellers
sellers’ costs by $1.50
P per pizza.
S2
$11.50 Sellers will supply 500
Tax S1
pizzas only if P rises to
$10.00 $11.50, to compensate
for this cost increase.
Hence, a tax on sellers
shifts the S curve up by
D1 the amount of the tax.

Q
500

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 A Tax on Sellers

Effects of a $1.50 per

unit tax on sellers New equilibrium:
P • Q = 450
S2 • Buyers pay PB =
S1
PB = $11.00
Tax
$11.00
$10.00
• Sellers receive
PS = $9.50
PS = $9.50
Difference
D1 between them =
$1.50 = tax
Q
450 500

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 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! P
S1
PB = $11.00
Tax
$10.00
A tax drives PS = $9.50
a wedge between
the price buyers D1
pay and the price
sellers receive. 450 500 Q

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 Tax Incidence
Video:

https://www.youtube.com/watch?v=1H5uU_
6Ax_4

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management system for classroom use.
 Elasticity and Tax Incidence
CASE 1: Supply is more elastic than demand

P It’s easier for

sellers than
Buyers’ share PB S buyers to leave
of tax burden the market.
Tax
Price if no tax So buyers bear
most of the
Sellers’ share PS burden of the tax.
of tax burden
D
Q

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 Elasticity and Tax Incidence
CASE 2: Demand is more elastic than supply

It’s easier for

P
S buyers than
Buyers’ share sellers to leave
of tax burden PB the market.
Sellers bear most
Price if no tax
Tax of the burden of
Sellers’ share the tax.
of tax burden PS
D

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 Who pays the luxury tax?
• 1990, Congress adopted a new luxury
tax
– On yachts, private airplanes, furs,
jewelry, expensive cars
– Goal: to raise revenue from those who
could most easily afford to pay
– Luxury items
• Demand is quite elastic
• Supply is relatively inelastic

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 CASE STUDY: Who Pays the Luxury Tax?
The market for
yachts
Demand is
P price-elastic.
S
Buyers’ share In the short run,
of tax burden PB
supply is inelastic.
Tax
Hence,
Sellers’ share companies
of tax burden PS that build
D
yachts pay
Q most of
the tax.

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