Ec10A, Chapter 6 Notes
Ec10A, Chapter 6 Notes Econ 10A
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This 3 page Class Notes was uploaded by Devon Black on Saturday September 17, 2016. The Class Notes belongs to Econ 10A at Harvard University taught by N. Gregory Mankiw in Fall 2016. Since its upload, it has received 4 views. For similar materials see Principles of Economics in Economics at Harvard University.
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Date Created: 09/17/16
th Principles of Economics, 7 ed. Chapter 6: Supply, Demand, and Government Policies I) Controls on Prices A) How Price Ceilings Affect Market Outcomes 1) If the price ceiling is above P* (equilibrium price) then the price ceiling is non-binding since the actual price will remain at equilibrium 2) If the price ceiling is below P*, then the price ceiling is a binding constraint, stopping the market from reaching equilibrium (a) Results in a permanent shortage (1) Long-lines (2) Ration the good and only sell it to certain people 3) Case Study: Lines at the Pumps (a) In the 1970s, when oil prices went up and oil supply went down (see Chapter 5), long lines became very common at gas stations (b) (c) Partially OPEC’s fault, but also partially the government’s fault because gas had a price ceiling (1) Initially, the price ceiling was non-binding, but when OPEC lessened its supply of oil, then the price ceiling became binding because prices were raised above the ceiling, resulting in an oil shortage 4) Case Study: Rent Control in the Short Run and the Long Run (a) Rent control helps the poor by making housing more affordable (b) Often results in a shortage (c) Long term (1) Suppliers respond to low rents by not building new apartments and by failing to upkeep their current ones (i) Why should they upkeep their apartments when if this complaining tenant leaves, there are 50 people waiting to take his place (2) Demand continues to increase as more people are lured into moving to the city by low rent prices (d) Fixes: (1) Long waiting lists (2) Preference to tenants without kids (3) Preference given to tenants of a certain race (4) Bribery (e) If there weren’t rent control, gentrification would occur rapidly B) How Price Floors Affect Market Outcomes 1) Non-binding price floors are ones that are placed below P* (a) Price stays at equilibrium 2) Binding price floors are put above P* (a) Results in a surplus – not enough people willing to pay the price floor for the good 3) Case Study: Minimum Wage (a) Binding minimum wage causes a labor surplus (i.e. unemployment) because there aren’t enough employers willing to pay the price floor (i.e. minimum wage) C) Evaluating Price Controls 1) Economists don’t like either price floors or price ceilings because they think the free market rules and support economic growth over everything including quality of life for those at the very bottom II) Taxes A) How Taxes on Sellers Affect Market Outcomes 1) Three Steps (a) Decide which curve is shifted (b) Decide which way the curve shifts (c) How are P* and Q* affected? 2) Example: $0.50 tax on ice cream sellers (a) Immediate impact is on the sellers – makes it less profitable to sell ice cream so the supply curve shifts left (1) To induce suppliers to sell any quantity of ice cream, the market price has to shift $0.50 upward to account for the tax (exact size of the shift) (b) The market price shifts upwards but not by the exact amount of the tax and the quantity of ice cream shifts downward (1) Sellers pay 20c of the tax whereas buyers pay 30c of the tax B) How Taxes on Buyers Affect Market Outcomes 1) Same three steps 2) Example: $0.50 tax on ice cream buyers (a) Demand curve shifts left because for them the price is higher (1) Exactly $0.50 shift in the demand curve for the same reason as in II.A.2.1 (b) Both P* and Q* fall 3) Implications (a) It doesn’t matter who you tax, the outcome will be the same (1) Wedge placed between the price that buyers pay and the price sellers receive 4) Case Study: Can Congress Distribute the Burden of a Payroll Tax? (a) When Congress created the payroll tax, it said that the firms had to pay half the tax and the employees had to pay half the tax (1) Wages fell to make up for the firms’ losses (b) Actual burden is decided by supply and demand C) Elasticity and Tax Incidence 1) Rarely is burden shared equally 2) If supply is more elastic than demand then the burden falls more on the consumers and vice versa for when demand is more elastic than supply (a) I.e. tax burden falls more heavily on the side of the market that is less elastic (b) Less options to switch to when there’s low elasticity 3) Case Study: Who Pays the Luxury Tax? (a) 1990: tax on yachts, private airplanes, expensive cars, jewelry, furs, etc. (b) Luxury items’ demands are very elastic whereas their supplies are not (c) Instead of raising more money from the rich, the burden fell on suppliers III) Conclusion Vocabulary Price Ceiling: a legal maximum on the price at which a good can be sold Price Floor: a legal minimum on the price at which a good can be sold Tax Incidence: the manner in which the burden of a tax is shared among participants in a market
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