Transcript san francisco and housing and prices

MARKETS IN ACTION
 Principles of
Microeconomic Theory,
ECO 284
 John Eastwood
 CBA 213
 523-7353
 e-mail address:
[email protected]
1
Learning Objectives
 Explain how price ceilings create shortages
and inefficiency
 Explain how price floors create surpluses
and inefficiency
 Explain the effects of the sales tax
 Define the total and excess burden of a tax.
2
Learning Objectives (cont.)
 Explain how markets for illegal goods work
 Explain why farm prices and revenues
fluctuate
 Explain how speculation limits price
fluctuations
3
Learning Objectives
 Explain how price ceilings create shortages
and inefficiency
 Explain how price floors create surpluses
and inefficiency
 Explain the effects of the sales tax
 Define the total and excess burden of a tax.
4
Housing Markets
and Rent Ceilings
 San Francisco Earthquake — 1906

How does the market deal with a dramatic
reduction in the supply of housing?
5
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
24
20
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
6
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
24
SS
20
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
7
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
8
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
SSa
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
9
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
SSa
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
10
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
SSa
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
11
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
SSa
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
12
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
SSa
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
13
Rent (dollars per unit per month)
The San Francisco
Housing Market in 1906
24
SS
20
LS
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
14
A Regulated Housing Market
 Price ceilings are regulations that make it
illegal to charge a price higher than a
specified level.
 Rent ceilings are price ceilings applied to
housing markets.
How does a rent ceiling affect
the housing market?
15
A Regulated Housing Market
 Rent ceilings set above equilibrium have no
effect.
 Rent ceilings set below equilibrium
prevents price from regulating the quantities
supplied and demanded.
16
Rent (dollars per unit per month)
A Rent Ceiling
SSa
24
20
Rent
ceiling
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
17
Rent (dollars per unit per month)
A Rent Ceiling
SSa
24
SS
20
Rent
ceiling
16
Housing
shortage
12
0
44
72
D
100
150
Quantity (thousands of units per month)
18
A Regulated Housing Market
 The ceiling results in two developments

Search activity

Black markets
19
A Regulated Housing Market
 Search activity is the time spent looking for
someone to do business.

Search activity increases when there is a
shortage
• an opportunity cost
20
A Regulated Housing Market
 Black markets are illegal markets in which
the price exceeds the legally imposed price
ceiling.
21
Rent (dollars per unit per month)
Inefficiency of Rent Ceilings
30
S
24
20
Rent
ceiling
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
22
Rent (dollars per unit per month)
Inefficiency of Rent Ceilings
30
S
24
20
Rent
ceiling
16
D
12
0
44
72
100
150
Quantity (thousands of units per month)
23
Rent (dollars per unit per month)
Inefficiency of Rent Ceilings
30
S
24
20
Rent
ceiling
16
12
D
Producer
surplus
0
44
72
100
150
Quantity (thousands of units per month)
24
Rent (dollars per unit per month)
Inefficiency of Rent Ceilings
30
S
24
Deadweight
loss
20
Rent
ceiling
16
12
D
Producer
surplus
0
44
72
100
150
Quantity (thousands of units per month)
25
Rent (dollars per unit per month)
Inefficiency of Rent Ceilings
Consumer
surplus
30
S
24
Deadweight
loss
20
Rent
ceiling
16
12
D
Producer
surplus
0
44
72
100
150
Quantity (thousands of units per month)
26
Learning Objectives
 Explain how price ceilings create shortages
and inefficiency
 Explain how price floors create surpluses
and inefficiency
 Explain the effects of the sales tax
 Define the total and excess burden of a tax.
27
The Labor Market
and the Minimum Wage
 Wage rates adjust to make the quantity
demanded of labor equal to the quantity
supplied

Technology has reduced the demand for lowskilled labor
28
The Labor Market
and the Minimum Wage
 Short-run

There is a given number of people with a given
skill.
• Wages must be increased in order to increase the
number of hours worked.
29
The Labor Market
and the Minimum Wage
 Long-run

People can acquire new skills and find new
types of jobs
• If wage rates are too high or low, people will enter
or leave this labor market.
• If people can freely enter and leave the labor market,
the long-run supply of labor is perfectly elastic.
• The longer the period of adjustment, the greater the
elasticity of supply of labor.
30
Wage Rate (dollars per hour)
A Market for Low-Skilled Labor
SS
6
LS
5
4
D
3
20
21
22
23
Quantity (millions of hours per year)
31
Wage Rate (dollars per hour)
A Market for Low-Skilled Labor
SS
6
LS
5
4
D
3
DA
20
21
22
23
Quantity (millions of hours per year)
32
Wage Rate (dollars per hour)
A Market for Low-Skilled Labor
SS
6
LS
5
4
D
3
DA
20
21
22
23
Quantity (millions of hours per year)
33
Wage Rate (dollars per hour)
A Market for Low-Skilled Labor
SSA
SS
6
LS
5
4
D
3
DA
20
21
22
23
Quantity (millions of hours per year)
34
Wage Rate (dollars per hour)
A Market for Low-Skilled Labor
SSA
SS
6
LS
5
4
D
3
DA
20
21
22
23
Quantity (millions of hours per year)
35
The Minimum Wage
 A minimum wage law is a regulation that
makes the hiring of labor below a specified
wage illegal.
 If the minimum wage is set below
equilibrium it will have no effect.
 If the minimum wage is set above
equilibrium, it prevents price from
regulating quantity supplied and demanded.
36
Wage Rate (dollars per hour)
Minimum Wage and Unemployment
SS
6
5
4
3
DA
20
21
22
23
Quantity (millions of hours per year)
37
Wage Rate (dollars per hour)
Minimum Wage and Unemployment
6
5
SS
Unemployment
a
b
Minimum
wage
4
3
DA
20
21
22
23
Quantity (millions of hours per year)
38
Learning Objectives
 Explain how price ceilings create shortages
and inefficiency
 Explain how price floors create surpluses
and inefficiency
 Explain the effects of the sales tax
 Define the total and excess burden of a tax.
39
Elasticity and the Burden of a Tax
 The economic incidence of taxation falls on
the persons who suffer reduced purchasing
power because of the tax.
 The legal incidence falls on the persons who
are required by law to pay the tax to the
government.
40
Burden “Shifting”
 If a tax is passed on to the consumer in the
form of higher prices, we say that the tax is
forward-shifted.
 A tax is said to be backward-shifted if
resource suppliers receive lower factor
payments (e.g., workers get lower take
home wages, or entrepreneurs earn lower
profits.).
41
Vocabulary
 An ad valorem tax is a percentage of price.
 A specific tax is a fixed amount per unit
sold, e.g., the excise tax we pay on gasoline.
42
Taxes
 Who Pays the Sales Tax?

Suppose a $10 sales tax is imposed on CD
players
 There are two prices

Including the tax — buyers respond to this
• what they pay -- P gross

Excluding the tax — sellers respond to this
• what they receive -- P net
43
Price (dollars per player)
The Sales Tax
S
110
105
100
95
DA
3
4
5
6
Quantity (thousands of CD players per week)
44
The Sales Tax
Price (dollars per player)
S + tax
S
110
$10 tax
105
100
95
DA
3
4
5
6
Quantity (thousands of CD players per week)
45
The Sales Tax
Price (dollars per player)
S + tax
S
110
$10 tax
105
Tax
revenue
100
95
DA
3
4
5
6
Quantity (thousands of CD players per week)
46
Elasticity and Slope
ed and slope are inversely related.
e
Q P Q P
Q P






Q
P
Q  P P Q
e
1
P
1
P

 

P
Q Slope Q
Q
d
d
47
Comparing Elasticities @ (Q,P)
 If D and S have the same slope, and
 if D and S cross at a point (Q,P),
 then their elasticities must be equal!
e
d
Q P
1
P
 es 
 

P Q Slope Q
48
Equal Elasticities, Equal Burdens
 Slope of the demand curve = -5/1
 Slope of the demand curve = 5/1
 Original equilibrium = (5,100)
e
d
1 100
 es  
4
5 5
49
Tax Incidence and
Elasticity of Demand
 Two Extremes

Perfectly inelastic demand--buyer pays
• Example: Insulin, Salt

Perfectly elastic demand--seller pays
• Example: Pink marker pens, Imported paper clips
50
Price (dollars per dose)
Sales Tax and the
Elasticity of Demand
S
2.20
Perfectly Inelastic
Demand
2.00
D
100
Quantity (thousands of doses per day)
51
Price (dollars per dose)
Sales Tax and the
Elasticity of Demand
S + tax
Buyer pays
entire tax
S
2.20
Perfectly Inelastic
Demand
2.00
D
100
Quantity (thousands of doses per day)
52
Sales Tax and the
Elasticity of Demand
Price (cents per pen)
S
1.00
Perfectly Elastic
Demand
0.90
1
4
Quantity (thousands of marker pens per week)
53
Price (cents per pen)
Sales Tax and the
Elasticity of Demand
S + tax
S
1.00
Perfectly Elastic
Demand
Seller
pays
entire
tax
0.90
1
4
Quantity (thousands of marker pens per week)
54
Tax Incidence and
Elasticity of Demand
 The division of the tax depends upon
elasticity.


The more ________ the demand, the more the
buyer pays.
The more_________ the demand, the more the
seller pays.
55
Tax Incidence and
Elasticity of Demand
 The division of the tax depends upon
elasticity.


The more inelastic the demand, the more the
buyer pays.
The more elastic the demand, the more the
seller pays.
56
Tax Incidence and
Elasticity of Supply
 Two Extremes

Perfectly inelastic supply — seller pays
• Example: water from a mineral spring

Perfectly elastic supply — buyer pays
• Example: sand used to make silicon used by
computer chip makers, aluminum
57
Price (dollars per bottle)
Sales Tax and the
Elasticity of Supply
S
50
Perfectly Inelastic
Supply
45
D
100
Quantity (thousands of bottles per week)
58
Price (dollars per bottle)
Sales Tax and the
Elasticity of Supply
S
50
Seller pays
entire tax
Perfectly Inelastic
Supply
45
D
100
Quantity (thousands of bottles per week)
59
Price (cents per pound)
Sales Tax and the
Elasticity of Supply
Perfectly Elastic
Supply
11
10
S
D
3
5
Quantity (thousands of pounds per week)
60
Price (cents per pound)
Sales Tax and the
Elasticity of Supply
Perfectly Elastic
Supply
11
S + tax
buyer pays
entire tax
10
S
D
3
5
Quantity (thousands of pounds per week)
61
Tax Incidence and
Elasticity of Supply
 The division of the tax depends upon
elasticity.

The more__________ the supply, the more the
seller pays.

The more __________ the supply, the more the
buyer pays.
62
Tax Incidence and
Elasticity of Supply
 The division of the tax depends upon
elasticity.

The more inelastic the supply, the more the
seller pays.

The more elastic the supply, the more the buyer
pays.
63
Sales Taxes in Practice
 Items with low elasticity of demand
(alcohol, tobacco, & gasoline) are good
sources of tax revenue for the government.
Why?
 Poor source: 1991 Luxury Tax
64
Taxes and Efficiency
 Inefficiency


Due to the difference in price paid by the buyer
and received by the seller the marginal benefit
does not equal the marginal cost.
The more inelastic demand or supply, the
smaller the decrease in quantity and deadweight
loss.
65
Price (dollars per player)
Taxes and Efficiency
130
S
105
100
95
75
0
D
1 2 3 4 5 6 7 8 9 10
Quantity (thousands of CD players per week)
66
Price (dollars per player)
Taxes and Efficiency
130
S + tax
S
105
100
95
75
0
D
1 2 3
4 5 6 7 8 9 10
Quantity (thousands of CD players per week)
67
Price (dollars per player)
Taxes and Efficiency
130
Consumer
surplus
S + tax
S
105
100
95
75
0
Producer
surplus
1 2 3
D
4 5 6 7 8 9 10
Quantity (thousands of CD players per week)
68
Price (dollars per player)
Taxes and Efficiency
130
Consumer
surplus
S + tax
S
105
Tax Revenue
100
95
75
0
Producer
surplus
1 2 3
D
4 5 6 7 8 9 10
Quantity (thousands of CD players per week)
69
Price (dollars per player)
Taxes and Efficiency
130
Consumer
surplus
S + tax
S
105
Tax Revenue
100
95
75
0
Producer
surplus
1 2 3
Deadweight
loss
D
4 5 6 7 8 9 10
Quantity (thousands of CD players per week)
70
Unit Tax when |ed|> es
Price ($/keg)
120
Demand
Supply
S + Tax
100
80
60
40
20
0
0
5
10
15 20 25 30 35
Quantity (kegs/day)
40
45
50
55
60
71
Tax Burden:|ed| >1 and es < 1.
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = -10 + 2Q. (es <1.)
 Solve for equilibrium quantity:
72
Tax Burden:|ed| >1 and es < 1.
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = -10 + 2Q. (es <1.)
 Solve for equilibrium quantity:

-10 + 2Qe = 60 - Qe
73
Tax Burden:|ed| >1 and es < 1.
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = -10 + 2Q. (es <1.)
 Solve for equilibrium quantity:


-10 + 2Qe = 60 - Qe
3Qe = 70
74
Tax Burden:|ed| >1 and es < 1.
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = -10 + 2Q. (es <1.)
 Solve for equilibrium quantity:



-10 + 2Qe = 60 - Qe
3Qe = 70
Qe = 23.33 kegs per day (|ed|>1 if Q<30.)
 Solve for equilibrium price:

Pe =
75
Tax Burden:|ed| >1 and es < 1.
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = -10 + 2Q. (es <1.)
 Solve for equilibrium quantity:



-10 + 2Qe = 60 - Qe
3Qe = 70
Qe = 23.33 kegs per day (|ed|>1 if Q<30.)
 Solve for equilibrium price:

Pe = 60 - Qe = 60 - 23.33 = $36.67 per keg.
76
Tax Burden with Demand More
Elastic than Supply
 Add the tax to Supply:

P = -10 + 2Q + 10 = 2Q (Now es = 1.)
 Solve for new equilibrium quantity, Qn :

2Qn = 60 - Qn
77
Tax Burden with Demand More
Elastic than Supply
 Add the tax to Supply:

P = -10 + 2Q + 10 = 2Q (Now es = 1.)
 Solve for new equilibrium quantity, Qn :



2Qn = 60 - Qn
3Qn = 60
Qn =
78
Tax Burden with Demand More
Elastic than Supply
 Add the tax to Supply:

P = -10 + 2Q + 10 = 2Q (Now es = 1.)
 Solve for new equilibrium quantity, Qn :



2Qn = 60 - Qn
3Qn = 60
Qn = 20 kegs per day
79
Tax Burden with Demand More
Elastic than Supply
 Add the tax to Supply:

P = -10 + 2Q + 10 = 2Q (Now es = 1.)
 Solve for new equilibrium quantity, Qn :



2Qn = 60 - Qn
3Qn = 60
Qn = 20 kegs per day
 Solve for gross price (buyers pay):

Pgross =
80
Tax Burden with Demand More
Elastic than Supply
 Add the tax to Supply:

P = -10 + 2Q + 10 = 2Q (Now es = 1.)
 Solve for new equilibrium quantity, Qn :



2Qn = 60 - Qn
3Qn = 60
Qn = 20 kegs per day
 Solve for gross price (buyers pay):

Pgross = 60 - Qn = 60 - 20 = $40 per keg.
81
Tax Burden with Demand More
Elastic than Supply
 To solve for net price ($ seller keeps),
subtract the tax from the gross price

Pnet = Pgross -Tax =
82
Tax Burden with Demand More
Elastic than Supply
 To solve for net price ($ seller keeps),
subtract the tax from the gross price

Pnet = Pgross -Tax = $40 - $10 = $30 per keg.
 Or, find the net price by substituting Qn into
the original supply curve:

Pnet = -10 + 2 Qn =
83
Tax Burden with Demand More
Elastic than Supply
 To solve for net price ($ seller keeps),
subtract the tax from the gross price

Pnet = Pgross -Tax = $40 - $10 = $30 per keg.
 Or, find the net price by substituting Qn into
the original supply curve:

Pnet = -10 + 2 Qn = -10 + 2(20) = $30 per keg.
84
Compute|ed| and es
 Before the tax Pe = $36.67/keg and Qe = 23.33
kegs/day. The slope of D = -1, while the slope of
S = 2.
e
d
1
P 1 36.67

  

Slope Q 1 23.33
1
P 1 36.67
es  Slope  Q  2  23.33 
85
Compute|ed| and es
 Before the tax Pe = $36.67/keg and Qe = 23.33
kegs/day. The slope of D = -1, while the slope of
S = 2.
e
d
1
P 1 36.67

  
 157
.
Slope Q 1 23.33
1
P 1 36.67
es  Slope  Q  2  23.33  0.79
86
Now Who Pays the Tax?
 Consumers now pay ___ per keg

$_____ / keg more than before the tax
 Vendors now receive ___ per keg,



but must pay the ___ per keg tax.
Sellers keep only ___ per keg.
_____ / keg less than before
 Sellers respond ____ to a change in price,
so they pay _____ of the tax.
87
Now Who Pays the Tax?
 Consumers now pay $40 per keg

$3.33 / keg more than before the tax
 Vendors now receive $40 per keg,



but must pay the $10 per keg tax.
Sellers keep only $30 per keg.
$6.67 / keg less than before
 Sellers respond less to a change in price, so
they pay more of the tax.
88
Unit Tax when |ed|< es
Price ($/keg)
60
Demand
Supply
S + Tax
50
40
30
20
10
0
0
5
10
15
20
25
30
35
40
45
50
55
60
Quantity (kegs/day)
89
Tax Burden:|ed|< 1 and es > 1
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = 4+ 0.4Q. (es >1.)
 Solve for equilibrium quantity:

4+ 0.4Qe = 60 - Qe
90
Tax Burden:|ed|< 1 and es > 1
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = 4+ 0.4Q. (es >1.)
 Solve for equilibrium quantity:



4+ 0.4Qe = 60 - Qe
1.4Qe = 56
Qe =
91
Tax Burden:|ed|< 1 and es > 1
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = 4+ 0.4Q. (es >1.)
 Solve for equilibrium quantity:



4+ 0.4Qe = 60 - Qe
1.4Qe = 56
Qe = 40 kegs per day (|ed|<1 if Q>30.)
 Solve for equilibrium price:

Pe =
92
Tax Burden:|ed|< 1 and es > 1
 Demand from Keg Ex: P = $60 - Q
 Let Supply be: P = 4+ 0.4Q. (es >1.)
 Solve for equilibrium quantity:



4+ 0.4Qe = 60 - Qe
1.4Qe = 56
Qe = 40 kegs per day (|ed|<1 if Q>30.)
 Solve for equilibrium price:

Pe = 60 - Qe = 60 - 40 = $20 per keg.
93
Tax Burden with Demand Less
Elastic than Supply
 Add the tax to Supply:

P = 4+ 0.4Q + 10 = 14+ 0.4Q (es > 1.)
 Solve for new equilibrium quantity, Qn :

14+ 0.4Qn = 60 - Qn
94
Tax Burden with Demand Less
Elastic than Supply
 Add the tax to Supply:

P = 4+ 0.4Q + 10 = 14+ 0.4Q (es > 1.)
 Solve for new equilibrium quantity, Qn :



14+ 0.4Qn = 60 - Qn
1.4Qn = 46
Qn =
95
Tax Burden with Demand Less
Elastic than Supply
 Add the tax to Supply:

P = 4+ 0.4Q + 10 = 14+ 0.4Q (es > 1.)
 Solve for new equilibrium quantity, Qn :



14+ 0.4Qn = 60 - Qn
1.4Qn = 46
Qn = 32.86 kegs per day
 Solve for gross price (buyers pay):

Pgross =
96
Tax Burden with Demand Less
Elastic than Supply
 Add the tax to Supply:

P = 4+ 0.4Q + 10 = 14+ 0.4Q (es > 1.)
 Solve for new equilibrium quantity, Qn :



14+ 0.4Qn = 60 - Qn
1.4Qn = 46
Qn = 32.86 kegs per day
 Solve for gross price (buyers pay):

Pgross = 60 - Qn = 60 - 32.86 = $27.14 per keg.
97
Tax Burden with Demand Less
Elastic than Supply
 To solve for net price ($ seller keeps),
subtract the tax from the gross price

Pnet = Pgross -Tax =
 Or, find the net price by substituting Qn into
the original supply curve:

Pnet = 4 + 0.4Qn =
98
Tax Burden with Demand Less
Elastic than Supply
 To solve for net price ($ seller keeps),
subtract the tax from the gross price

Pnet = Pgross -Tax = 27.14 - 10 = $17.14
 Or, find the net price by substituting Qn into
the original supply curve:

Pnet = 4 + 0.4Qn = 4 + 0.4(32.86 ) = $17.14
99
Compute|ed| and es
 Before the tax Pe=$20/keg and Qe=40 kegs/day.
The slope of D = -1, while the slope of S = 0.4
e
d
1
P

 
Slope Q
1
P



es Slope Q
100
Compute|ed| and es
 Before the tax Pe=$20/keg and Qe=40 kegs/day.
The slope of D = -1, while the slope of S = 0.4
e
d
1
P 1 20

  
 0.50
Slope Q 1 40
1
P
1 20
.
es  Slope  Q  0.4  40  125
101
Who Pays Most of the Tax?
 Consumers now pay $_____ per keg,

$_____ per keg more than before the tax.
 Vendors now receive $_____ per keg,



but must pay the $___ per keg tax.
Sellers keep only $____ per keg,
$_____ per keg less than before the tax.
 Buyers respond _____ to a change in price,
so they pay _____ of the tax.
102
Who Pays Most of the Tax?
 Consumers now pay $27.14 per keg,

$7.14 per keg more than before the tax.
 Vendors now receive $27.14 per keg,



but must pay the $10 per keg tax.
Sellers keep only $17.14 per keg,
$2.86 per keg less than before the tax.
 Buyers respond less to a change in price, so
they pay more of the tax.
103
Price ($/keg)
Example with |ed| = es
80
70
Demand
Supply
S + Tax
60
50
40
30
20
10
0
0
5
10
15
20
25
30
35
40
45
50
55
60
Quantity (kegs/day)
104
Who Pays Most of the Tax?
 Consumers now pay $_____ per keg,

$_____ per keg more than before the tax.
 Vendors now receive $_____ per keg,



but must pay the $___ per keg tax.
Sellers keep only $____ per keg,
$_____ per keg less than before the tax.
 When the buyers and sellers have the same
elasticities, the tax burden is ___________.
105
Who Pays Most of the Tax?
 Consumers now pay $40 per keg,

$5.00 per keg more than before the tax.
 Vendors now receive $40 per keg,



but must pay the $10 per keg tax.
Sellers keep only $30 per keg,
$5.00 per keg less than before the tax.
 When the buyers and sellers have the same
elasticities, the tax burden is equally shared.
106
A Workable General Principle
 They who respond
least to the change
in price pay the
majority of the tax.
107
Learning Objectives
 Explain how price ceilings create shortages
and inefficiency
 Explain how price floors create surpluses
and inefficiency
 Explain the effects of the sales tax
 Define the total and excess burden of a tax.
108
Total Burden of a Tax
 The amount that, if paid to “taxpayers,”
would make them just as well off with the
tax as without it.
109
Excess Burden of a Tax
 Excess burden = total burden - tax revenue
 Includes:



administrative cost
compliance cost
deadweight loss
 Further reading: Chapter 18, pages 398-403.
110
Learning Objectives (cont.)
 Explain how markets for illegal goods work
 Explain why farm prices and revenues
fluctuate
 Explain how speculation limits price
fluctuations
111
Markets for Prohibited Goods
 When a good is illegal, the cost of trading in
the good increases.
 Penalties and policing increase the cost.

Decreases supply and/or demand
112
Price
A Market for a Prohibited Good
S
Pc
c
D
Qc
Quantity
113
A Market for a Prohibited Good
Price
S + CBL
a
S
Pp
Pc
c
D
Qp
Qc
Quantity
114
Price
A Market for a Prohibited Good
a
S
Pc
c
b
Pp
D
D - CBL
Qp
Qc
Quantity
115
A Market for a Prohibited Good
Price
S + CBL
a
Pc
S
d
c
b
D
D - CBL
Qp
Qc
Quantity
116
Price
A Market for a Prohibited Good
Pc
S + CBL
Cost per unit
of breaking
the law...
…to
buyer
…to
seller
a
S
d
c
b
D
D - CBL
Qp
Qc
Quantity
117
Markets for Prohibited Goods
 Enforcement

Price effects depend upon who receives the
most severe penalty — the buyer or seller

Today, penalties on sellers are larger
• This causes the equilibrium quantity to decrease and
price increases compared to an unregulated market.
118
Learning Objectives (cont.)
 Explain how markets for illegal goods work
 Explain why farm prices and revenues
fluctuate
 Explain how speculation limits price
fluctuations
119
Stabilizing Farm Revenues
 Farm output fluctuates considerably due to
fluctuations in the weather.
 How do changes in farm output affect farm
prices and farm revenues?
 How can farm revenues be stabilized?
120
Stabilizing Farm Revenues
 Farm Revenues during a bad harvest

Total farm revenue actually increases due to
inelastic demand.

Some farmers, whose entire crop is destroyed,
lose.

Others, whose crop is unaffected, earn
enormous profits.
121
Price (dollar per bushel)
Harvest, Farm Prices,
and Farm Revenues
MS0
8
Poor
Harvest
6
4
2
0
D
5
10
15
20
25
Quantity (billions of bushels per year)
122
Price (dollar per bushel)
Harvest, Farm Prices,
and Farm Revenues
MS1
MS0
8
Poor
Harvest
6
$30 billion
4
2
$60 billion
0
5
$20
billion
D
10
15
20
25
Quantity (billions of bushels per year)
123
Stabilizing Farm Revenues
 Farm Revenues during a bumper harvest

Total farm revenue actually decreases due to
inelastic demand.
124
Price (dollar per bushel)
Harvest, Farm Prices,
and Farm Revenues
MS0
8
Bumper
Harvest
6
4
2
0
D
5
10
15
20
25
Quantity (billions of bushels per year)
125
Price (dollar per bushel)
Harvest, Farm Prices,
and Farm Revenues
MS0
MS2
8
6
Bumper
Harvest
4
$40 billion
2
$40 billion
0
5
$10
billion
D
10
15
20
25
Quantity (billions of bushels per year)
126
Learning Objectives (cont.)
 Explain how markets for illegal goods work
 Explain why farm prices and revenues
fluctuate
 Explain how speculation limits price
fluctuations
127
Stabilizing Farm Revenues
 Two institutions designed to stabilize farm
revenue

Speculative markets in inventories

Farm price stabilization policy
128
Price (dollar per bushel)
How Inventories Limit
Price Changes
Inventory
Speculation
8
6
S
4
2
0
D
5
10
15
20
25 Quantity
(billions of bushels)
129
Price (dollar per bushel)
How Inventories Limit
Price Changes Q
1
Inventory
Speculation
8
6
S
4
2
0
D
5 billion from
inventory
5
10
15
20
25 Quantity
Inventory
(billions of bushels)
130
Price (dollar per bushel)
How Inventories Limit
Price Changes
Q2
Inventory
Speculation
8
6
S
4
2
D
5 billion to
inventory
0
5
10
15
20
25 Quantity
Inventory
(billions of bushels)
131
Farm Revenue
 Speculative markets in inventories do not
stabilize farm revenue

When price is stabilized, revenue fluctuates as
production fluctuates.

Bumper crops bring larger revenues than poor
harvest do.
132
Farm Revenue
 Farm Price Stabilization Policy



Set production limits
Set price floors
Hold inventories
133
Farm Revenue
 Farm Price Stabilization Policy

Production limits
• Quotas restrict the quantity produced
– can result in higher farm prices

Price floors
• set above equilibrium create surpluses

Hold inventories
• the government must hold inventory to maintain the
equilibrium price
134