Econ 201 Chapter 6 Notes
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This 3 page Class Notes was uploaded by Kathryn Catton on Thursday March 17, 2016. The Class Notes belongs to ECON 2010 at a university taught by Dr. Zegeye in Winter 2016. Since its upload, it has received 41 views.
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Date Created: 03/17/16
Chapter 6: Supply, Demand, and Government Policies Direct Controls on Prices: Because buyers of any good always want a lower price while sellers want a higher price, the interests of the two groups conflict. The government can impose a legal maximum on the price for the products to be sold. Because the price is not allowed to rise above this level, the legislated maximum is called a price ceiling. In contrast, the government can impose a legal minimum on the price. Because the price cannot fall below this level, the legislated minimum is called a price floor. Price Ceilings: If the price ceiling is below equilibrium, it is NOT BINDING. Market forces naturally move the economy to the equilibrium, and the price ceiling has no effect on the price or quantity sold. If the price ceiling is above equilibrium, it is a BINDING CONSTRAINT. Once it hits the ceiling, it can’t by law rise any further. If equilibrium is at $3 an ice cream cone, it would be NOT BINDING at $4 price ceiling and BINDING at $2 price ceiling. At this point, if Quantity demanded exceeds Quantity Supplied, there is a shortage. **When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers** Price Floors: like ceilings, price floors are an attempt by the government to maintain prices at other than equilibrium levels. Unlike ceilings, a price floor places a legal minimum price. If the equilibrium is above the price floor, the floor is NOT BINDING. If the equilibrium is below the floor, the price floor is a BINDING CONSTRAINT. Once it hits the floor, it can’t go lower. **A binding price floor causes a surplus** Evaluating Price Controls: One of the Ten Principles of Economics states why economists usually oppose price ceilings and floors. Prices to them, are the result of business and consumer decisions that lie behind the supply and demand curves. Prices balance supply and demand, coordinating economic activity. Price controls are also usually aimed at the poor, such as the rent- control laws and the minimum wage laws. Taxes: important tool used to raise revenue for public projects, like roads, schools and national defense. A tax incidence shows how a tax is divided to take the burden on either the suppliers or buyers. How taxes on sellers affect market outcomes: Suppose the local government passes a law requiring sellers of ice cream cones to send $.50 to the government for each cone they sell. How are buyers and sellers affected? 1) Decide whether the law affects the supply curve or demand curve 2) Decide which way the curve shifts 3) Examine how the shift affects the equilibrium price and quantity. 1) Demand remains the same, however the supply curve shifts because the tax is on the sellers and it makes the ice cream business less profitable at any price 2) The tax reduces the quantity supplied at every price, supply curve shifts to the left. It moves upward as well because of the $.50 tax (slightly). Price must be $.50 higher. 3) Price increases and quantity supplied decreases. Tax reduces the size of the ice cream market. Who pays the tax? (Tax incidence)- Both buyers and sellers share the burden, the market price rises and buyers pay $.30 more for each cone. Sellers get a higher price from buyers than before, but what they get to keep after paying the tax is $2.80 compared to the $3 before tax. How taxes on buyers affect market outcomes: Now a tax is levied on buyers of a good. They have to send $.50 to the government for each cone they buy. 1) Supply is not affected but the demand curve is affected. 2) Buying ice cream is less attractive with a tax, demand curve shifts to the left. It shifts downward as well because of the $.50 tax. 3) Price decreases for the sellers from $3.00 to $2.80 but rise for the buyers to $3.30. (+$.50). The quantity demanded of cones decreases as well. Both the buyers and sellers share the burden. Elasticity and Tax Incidence: The tax burden is rarely shared equally, how do we figure it out? The relative elasticity of supply and demand. When supply is elastic, sellers are very responsive to changes in price, whereas buyers aren’t very responsive. When the tax is imposed, the price received by sellers doesn’t fall much, so they carry a small burden. However, the price paid by buyers rises substantially, the buyers end up bearing the most burden of the tax. The more elastic supply or demand is, the lesser amount of burden you have. The elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable. A small elasticity of demand means that buyers do not have good alternative to consuming this particular good. A small elasticity of supply means that sellers do not have good alternatives to producing this good. When the good is taxed, the side of the market with fewer good alternatives is less willing to leave the market and has the bigger burden. Consumer Surplus: difference between what an individual is willing to pay minus what he or she ends up actually paying. Producer Surplus: Price minus Marginal Cost. Market Efficiency and Market Failure: I. To conclude that markets are efficient, we made several assumptions about how the market worked. a. Perfectly competitive market b. No externalities II. When these assumptions do not hold, the market equilibrium may not be efficient. III. When markets fail, public policy can potentially remedy the situation.
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