Supply, Demand, and Government Policies

00:01 Hello, and welcome back to your online presentation in Microeconomics.

00:04 My name is James DeNicco.

00:06 This presentation is gonna be about Supply, Demand, and Government Policies; or how different government policies affect supply and demand.

00:14 So in this presentation, we'll be learning about price ceilings and price floors.

00:19 We'll be looking at taxes, how they affect supply and demand.

00:23 I'll be looking at who pays taxes and what determines the tax incidence or the distribution of taxes.

00:29 So the first government policy that we're gonna look at is the price ceiling.

00:34 Now a price ceiling, when the government sets a price ceiling, they're saying that's the highest a price can go.

00:40 So let's take a look at how setting a price ceiling can affect supply and demand.

00:46 So here we are with our market equilibrium where supply and demand meet each other.

00:50 So the government sets a price ceiling well if they set the price ceiling above the market equilibrium it's gonna have no effect.

00:58 You're saying the price cannot go above this and the price already does not go above that, right? The market equilibrium decided the price below the price ceiling.

01:07 Now, if you set the price ceiling below the market equilibrium, that's gonna be what we call, binding.

01:13 You're saying the price cannot go above this, but the market equilibrium determine that it wants to be above that, so what's gonna be the result? Well, the result here is gonna be that demand is greater than supply.

01:26 A binding price ceiling creates a shortage.

01:29 So why might the government want to institute a price ceiling? So let's take a look at these examples of rent, say they don't want rent to go too high so people can afford to rent homes or rent apartments, alright? So let's take a look on at what that does.

01:45 In the short run here, you'll notice, yes, by lowering the price you're gonna increase the demand, alright, so you're gonna create a shortage, demand is gonna be greater than supply.

01:57 But you'll notice in the short run supply is very inelastic.

02:01 It's hard for people to own homes or apartments to get rid of those homes or apartments in the short run.

02:07 They might want to because now there's been a price that's been forced to go lower so it's maybe not as profitable for them to rent homes and apartments out, but they can't get rid of those homes and apartments in the short run.

02:19 So the shortage in the short run won't be as bad as it is in the long run.

02:23 Now in the long run, you'll notice that both demand and supply are more elastic than in the short run.

02:30 So demand is more elastic in the long run because people are able to move out of their current situations more easily, right? In the long run, hey, I can get out of mom and dad's basement and go rent an apartment.

02:41 Supply is more elastic because overtime people that owns home or own apartments can get rid of them or acquire them more easily in the long run.

02:51 So if prices are forced too low, in the long run, the tenants might unload some of those apartments or homes, they might decrease the supply.

03:01 So you're gonna see with the very elastic demand and supply instituting that price ceiling creates a larger shortage.

03:10 So that's one of the implications of the government instituting price regulation here a price ceiling.

03:17 We also have price floors.

03:19 So a price floor is when the government comes in and says, this is the lowest the price can go.

03:24 Now, if they set the price floor below the market equilibrium, it's not gonna be binding.

03:29 You're saying this is the lowest it can go and it already doesn't go that low so it's not gonna have any effect on supply and demand.

03:36 Now if you set a price floor above the market equilibrium, it is going to be binding.

03:41 You're saying the price can't get down to where the market equilibrium wants it to be.

03:45 In that case, that higher price is gonna cause an increase in supply and a decrease in demand is gonna create a surplus.

03:54 So in what context might the government want to set a price floor? Well, the best known one is probably the minimum wage, right? So you're saying this is the lowest amount you can pay people.

04:06 So if you set that minimum wage above the market equilibrium, what's gonna be the result? Well, here you're kinda picking winners and losers, right, it's gonna depend on how elastic that demand curve is, how many winners and how many losers there are gonna be.

04:21 In this example here, let's take a look. So where our market equilibrium real wage, so here the price of labor is the wage and the long horizontal access is the quantity of labor.

04:33 So we'll notice as wages go down, we demand more labor, right? As wage go down we supply less labor as wages go up, we supply more labor.

04:43 So our market equilibrium real wage was determined to be right here where supply and demand meet each other.

04:49 The government comes in and says, that wage is too low, we have to set a minimum wage above that so with that higher wage, it's gonna induce a larger labor supply and it's gonna affect labor demand is gonna decrease, there's gonna be a decrease in labor demand as the price of labor goes up.

05:08 So now we have supply greater than demand, that's a surplus.

05:12 A surplus in the labor market is called unemployed, alright, those are unemployed workers, they're looking for work and cannot find work so we went from no unemployment here to having some unemployment.

05:25 We pick some winners and we pick some losers. Well, who wins? The people that maintain their job, these people right here, they had a job before, now they have a job with the higher wage The lossers, those are gonna be the people right here. They have jobs before right at that lower wage, now the wage goes up and the demand for workers moves along the curve to the left, there's less demand for labor with those higher wages so those people get lock up, right? The people over here, with that higher wage, now they want to work before they didn't want to work with the market equilibrium wage with the higher wage that increase the supply more people wanna work, but they can't find work, so I say they're neither winners or losers, right? They didn't have a job before, they don't have a job now, but they're all looking for a job so in some sense, I guess you could say they're losing out.

06:14 But this is your standard minimum wage graph and your standard example of a price floor.

06:20 So let's talk about taxes, alright, everybody's favorite subject, taxes.

06:26 First the tax incidence.

06:28 The manner in which the tax burden or the manner in which the burden of a tax is shared among participants, alright, let's look at what affects that tax incidence, who pays taxes? So first, let's take a look at an example of a tax on a seller.

06:45 So here in our graph here we're gonna have the market for ice cream cones, alright, so on the vertical axis is the price of our ice cream cones, along the horizontal axis it's gonna be the quantity of ice cream cones we sell, so our quantity or our equilibrium quantity was determined to be a hundred and the equilibrium price was $3.

07:04 Now the government wants to raise some revenue off the sale of these ice cream cones, so they're gonna implement a $0.50 tax on the seller.

07:13 So for every ice cream cone you sell, you have to pay the government $0.50.

07:18 What thats gonna do is shift the supply of ice cream to the left, okay, you're taking away what the supplier can earn with each ice cream cone they sell, so supply is gonna shift to the left.

07:31 When you tax the seller, it's supply that it's affected because the seller is the one that produces the supply, those are sellers are the one who determine the supply so you're gonna have a $0.50 shift to the left in supply.

07:45 So what's that gonna result in? Well, this is gonna be our new equilibrium now.

07:49 We're gonna have only 90 ice cream cone are sold, and it's gonna be at a price of $3.30 so who's gonna pay that taxes? Well, it's gonna be shared.

07:59 It's gonna be shared if you draw the line straight going down from the quantity here to our new equilibrium you'll see this is gonna be the price that buyers pay, alright, but the government is taking $0.50 of that so $0.50 less, that's what the seller's gonna receive.

08:16 The price before was $3 so let's take a look who's paying that tax.

08:22 You tax the seller but both the buyer and the seller are gonna pay some of that tax.

08:28 So you'll see here, the price the buyers pay went from $3 to $3.30 so $0.30 of that $0.50 increase in taxes is going to the buyer.

08:39 Now, the price the sellers receive goes from $3 to $2.80.

08:45 So what does that mean? The seller is paying $0.20 of that tax.

08:49 Even though you tax the seller, even though you tax them $0.50, part of that tax is gonna be passed on to the buyer.

08:59 They're not gonna eat all of that tax, they're gonna pass some of it on.

09:02 So you see, buyers and sellers will share the burden with some of the tax being passed on so we have this $0.50 leftward shift in supply, some of that, $0.30 is gonna be paid by the buyer, $0.20 is gonna be paid by the seller.

09:16 Now, how about if we flip it around, how about if we tax the buyer, what happens? Well the only real difference here, the demand is gonna shift to the left.

09:25 The product is more expensive so you're gonna see a leftward shift in the demand curve.

09:30 You're gonna demand less with that tax, so what's the result? What you're gonna find the result hasn't changed at all, really.

09:38 So we have a leftward shift in the demand curve of $0.50, what does that mean? Now we have our new equilibrium down here.

09:45 The quantity again is 90, the price the sellers received is $2.80, the price the buyers pay is $3.30.

09:54 Nothing's changed, that's very interesting right, you tax the seller you tax the buyer but nothing changes, it doesn't matter who you tax, some of that tax is gonna be passed on, okay? So, the size of the tax and who you actually tax doesn't affect the tax incidence, it doesn't affect who is paying that tax, alright, because things are just passed on, the buyers and sellers will share the burden of the tax, it just affects which curves shifts, okay, so before, when you tax the seller, supply shift to the left $0.50, it raise the price buyers pay to $3.30 that's what they pay but the seller only receives $2.80 cuz you're taxing the seller $0.50.

10:41 Here you tax the buyer, demand shifts to the left by $0.50, so now what happens, right? The buyer is paying $3.30 but again the seller is only receiving $2.80 because of that $0.50 tax, it doesn't affect the tax incidence, it doesn't affect who's paying the taxes. Those taxes are shared or passed along.

11:04 So this also applies to the labor market.

11:07 Just like in the goods market, the division of the tax burden between workers and firms doesn't depend on whether you tax the firm or whether you tax the worker, they're gonna share that tax.

11:19 So if you're trying to tax the firm on labor, some of that tax is gonna be passed on to the worker, it doesn't matter who you tax.

11:29 So here we have what's called the tax wedge, that's gonna be the difference between the wage firms pay and the wage that workers receive here so that's that labor tax wedge. So let's take a little closer look at this.

11:42 Let's take a look first here at a payroll tax on employers and then the payroll tax on employees.

11:47 And what you'll find is just like in the goods market it doesn't matter who you tax, they're gonna share the burden of that tax, it just matters as to which curve is gonna shift.

11:58 So first here, payroll tax on employers.

12:01 You're taxing the employers so the curve that's gonna shift is the labor demand curve.

12:05 The employers constitute the labor demand, they demand workers to make products, so you'll see labor demand will shift to the left, this is the wage workers are gonna receive and this is the wage workers gonna pay, the difference is our tax wedge. Now how about if you tax the employees? Well, the result is gonna be the same, it's just gonna be a different curves that shifts.

12:26 Now, it'll be the labor supply curve that shifts.

12:29 The employees make up the labor supply, they're the once that provide the labor, so if you tax them there will be a leftward shift in the supply curve but you'll still have the same tax wedge, you'll still have the same wage the firms have to pay and the same wage that workers receive, it doesn't matter who you tax, the tax will be shared.

12:49 So what is tax incidence depend on? It doesn't matter who you tax, what it matters is the relative elasticities of demand and supply.

12:58 So in my example here, we have a relatively inelastic demand.

13:03 Demand is less elastic than supply so if you institute a tax that means the buyers are gonna share a larger burden of that tax.

13:13 Why is that? Because with relatively inelastic demand, that means that their behavior changes less.

13:20 As you change the price, as you institute that tax and raise the price of whatever they're purchasing, their behavior isn't gonna change that much.

13:28 They're not gonna decrease the quantity that they purchase by that large amount, so they'll continue to buy a large quantity of that good which means they'll pay a higher share of that tax burden.

13:40 Now we see this relatively more elastic supply. What does that mean? That means as the price the sellers receive goes down, they're gonna change the behavior more relative to the buyer, so as they change the behavior they're gonna supply less, and that means they're gonna share a lower amount of that tax burden.

14:00 What if we switch it around and we have relatively more elastic supply? Well, if supply is relatively more elastic, well, you're gonna see the seller is gonna bear a larger share of that burden because their behavior now is gonna be the one that changes less.

14:14 You institute a tax and the buyer, he's gonna change his behavior a lot, it's very elastic.

14:21 As the price goes up on that good, he's gonna demand a lot less so he's gonna pay a smaller share of that tax, but the supply side it's very inelastic, they don't change the amount that they supply by as a large of a quantity when the price they receive, the price the seller receives goes down.

14:40 So they're not gonna change that behavior that much they're gonna continue to produce a lot which means they're gonna pay a larger share of that tax burden.

14:48 So what have we learned? So we know how price ceilings and price floors affects supply and demand.

14:53 We know how taxes affect supply and demand.

14:56 We know that who you tax doesn't affect who actually pays the tax, whether you tax the employer or the employee, whether you tax the seller or the buyer, they're gonna share that tax burden.

15:09 And we also know it's the relative elasticities that determine who pays a larger share of that tax, it determines the tax incidence.

15:18 So that is your presentation on supply, demand, and government policies. Thank you.