Supply, Demand, and Government Policies 6 Supply, Demand, and Government Policies Economics P R I N C I P L E S O F N. Gregory Mankiw This chapter builds on the previous two (supply & demand and elasticity). Students who learned those chapters well usually do not have much difficulty with the material in Chapter 6. This chapter can usually be covered in about 90 minutes of class time. I have combined the analysis of price ceilings with the rent control example, and I’ve combined the analysis of price floors with the minimum wage example. (In contrast, the textbook presents a generic analysis of price ceilings, then the rent control example, then a generic analysis of price floors, then the minimum wage). Most students learn new concepts better in the context of a specific example rather than a generic analysis, and combining them in this way saves class time. Here’s an idea you might consider: At the end of the class session just prior to the one in which you begin to cover this chapter, ask students to take out a piece of blank paper, and write down whether they think the minimum wage should be increased, and their reason(s). Tell them not to write their names (you want them to be candid), and have them leave their pieces of paper in a pile as they exit the classroom. Later, divide the papers into two groups based on whether they support or oppose increasing the minimum wage. In this PowerPoint file, immediately after this slide, insert new two slides, titling them “Your reasons for raising the minimum wage” and “Your reasons for not raising the minimum wage.” Summarize on each slide the most common reasons students gave. Begin the class session by showing them the results of this impromptu survey (how many students responded each way, and the most common reasons). Tell those students that support a minimum wage increase that their thinking represents that of many educated non-economists. But tell them that economics offers another perspective, and this is something they will learn in this chapter. If you do this, then I recommend rearranging the slides a bit so that the price floor/minimum wage slides come BEFORE the price ceiling/rent control slides. Premium PowerPoint Slides by Ron Cronovich

In this chapter, look for the answers to these questions: What are price ceilings and price floors? 가격상한과 하한은 무엇인가 What are some examples of each? 각각의 예는? How do price ceilings and price floors affect market outcomes? 가격상한과 하한은 시장에 어떤 영향을 미치는가? How do taxes affect market outcomes? 세금은 시장에 어떤 영향을 미치나? How do the effects depend on whether the tax is imposed on buyers or sellers? 세금이 판매자 또는 구입자에게 부과될때 그 효과는 어떻게 다른가? What is the incidence of a tax? 조세의 귀착은 무엇인가? What determines the incidence? 무엇이 조세의 귀착을 결정하나? When we talk about how a policy “affects the market outcome,” we mean the policy’s impact on the price and quantity of the good and therefore on the market’s allocation of resources. The concluding slide elaborates on this a bit. 1

Government Policies That Alter the Private Market Outcome 시장의 행태를 바꾸는 정부정책 Price controls 가격통제 Price ceiling: a legal maximum on the price of a good or service Example: rent control 가격상한: 재화와 서비스 가격의 법정 최고치(예 임대료 통제) Price floor: a legal minimum on the price of a good or service Example: minimum wage 가격하한: 재화와 서비스 가격의 법정 최저치(예 최저임금) Taxes(조세) : The govt can make buyers or sellers pay a specific amount on each unit bought/sold. 정부는 판매자나 구매자에게 판매/구매품 당 특정 금액을 지불하게 만들 수 있다. This slide outlines the chapter. We will use the supply/demand model to see how each policy affects the market outcome (the price buyers pay, the price sellers receive, and eq’m quantity). 각각의 정책이 시장에 어떤 영향을 주는지 수요공급 모델을 이용한다 (구입자 지불 가격, 판매자 수취 가격, 균형량) SUPPLY, DEMAND, AND GOVERNMENT POLICIES 2

EXAMPLE 1: The Market for Apartments 아파트 시장 Q Rental price of apts 임대료 S D $800 300 Eq’m w/o price controls 가격통제 없을 때의 균형 We start by analyzing the effects of a price ceiling. The most common example is rent control, so we do the analysis in the context of this example. We begin by showing the market for apartments in equilibrium (before the government imposes any price controls). Quantity of apartments 아파트 수량 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 3

How Price Ceilings Affect Market Outcomes 가격상한이 시장에 어떻게 영향을 미치는가? A price ceiling above the eq’m price is not binding – has no effect on the market outcome. 균형가격보다 높은 가격상한은 실효성이 없다- 시장에 아무런 영향을 미치지 못한다 P Q S Price ceiling 가격상한 $1000 D $800 300 When some students see this for the first time, they wonder why the price ceiling does not result in a surplus. When the price ceiling is above the equilibrium price, the equilibrium price is still perfectly legal. Just because landlords are allowed to charge $1000 rent doesn’t mean they will – if they do, they won’t be able to rent all of their apartments – a surplus will result, causing downward pressure on the price (rent). There’s no law that prevents the price (rent) from falling, so it does fall until the surplus is gone and equilibrium is reached (at P = $800 and Q = 300). SUPPLY, DEMAND, AND GOVERNMENT POLICIES 4

How Price Ceilings Affect Market Outcomes 가격상한이 시장에 어떻게 영향을 미치는가? The eq’m price ($800) is above the ceiling and therefore illegal. 균형가격($800)은 상한보다 높으므로 불법이다 The ceiling is a binding constraint on the price, causes a shortage. 가격상한은 가격을 구속하여 물량부족을 일으키면서 시장에 영향을 미친다. constraint(구속, 억제, 제약) P Q S D $800 Price ceiling $500 250 400 Shortage 물량부족 In this case, the price ceiling is binding. In the new equilibrium with the price ceiling, the actual price (rent) of an apartment will be $500. It won’t be more than that, because any higher price is illegal. It won’t be less than $500, because the shortage would be even larger if the price were lower. The actual quantity of apartments rented equals 250, and there is a shortage equal to 150 (the difference between the quantity demanded, 400, and the quantity supplied, 250). SUPPLY, DEMAND, AND GOVERNMENT POLICIES 5

How Price Ceilings Affect Market Outcomes Q In the long run, supply and demand are more price-elastic. 장기에는 공급과 수요는 더욱 가격탄력적이다 So, the shortage is larger. 그러므로 물량부족은 더 커진다 S D $800 Price ceiling $500 shortage In this slide, the equilibrium price ($800) and price ceiling ($500) are the same as on the preceding slides, but supply and demand are more price-elastic than before, and the shortage that results from a binding price ceiling is larger. 150 450 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 6

Shortages and Rationing 물량부족과 할당 With a shortage, sellers must ration the goods among buyers. 물량부족으로 판매자는 구매자들에게 재화를 할당 해 줄 수밖에 없다. Some rationing mechanisms 할당제 구조 : (1) Long lines (2) Discrimination according to sellers’ biases 1) 길게 늘어선 줄 2) 판매자의 편견에 근거한 차별대우 These mechanisms are often unfair, and inefficient: the goods do not necessarily go to the buyers who value them most highly. 이런 방식은 불공평하고 비효율적이다: 그 재화에 대해 가장 높은 가치를 부여하는(높은 가격을 지불하려는) 소비자에게 그 재화가 주어지지 않는다 In contrast, when prices are not controlled, the rationing mechanism is efficient (the goods go to the buyers that value them most highly) and impersonal (and thus fair). 반면에 가격이 통제되지 않을 때의 할당(배분)방식은 효율적이고 차별하지 않는다(가장 높은 가치를 부여하는 소비자에게 돌아간다)(공정하다) The last two bullets discuss “efficiency” in the context of rationing goods to those buyers who value them most highly. This concept will be explored further in the following chapter. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 7

EXAMPLE 2: The Market for Unskilled Labor 미숙련 노동자 시장 W L Wage paid to unskilled workers 미숙련자 임금 S D $4 500 Eq’m w/o price controls 가격통제 없을 때의 균형 Now we switch gears and look at the effects of a price floor. We illustrate this concept using the common textbook example – the minimum wage. This may be the first time students have seen a supply-demand diagram of the labor market. It might be useful to note that the “price” of labor is simply the wage, which we measure on the vertical axis of our supply-demand diagram. Along the horizontal axis, we measure the quantity of labor (number of workers). The demand for unskilled labor comes from firms. The supply comes from workers. We focus on unskilled labor because the minimum wage is not relevant for higher skilled, higher wage workers. Quantity of unskilled workers SUPPLY, DEMAND, AND GOVERNMENT POLICIES 8

How Price Floors Affect Market Outcomes 가격하한이 시장에 어떤 영향을 미치나? A price floor below the eq’m price is not binding – has no effect on the market outcome. 균형가격보 다 낮은 가격하한은 실효성이 없다- 시장에 영향을 미치지 못한다 W L S D $4 500 Price floor $3 Some students may wonder why the $3 price floor does not cause a shortage. After all, at a wage of $3, the quantity of unskilled workers that firms wish to hire exceeds the quantity of unskilled workers that are looking for jobs. But the minimum wage law does not stop the wage from rising above $3. So, in response to this shortage, the wage will rise until the shortage disappears – which occurs at the equilibrium wage of $4. The equilibrium wage is perfectly legal when the price floor (i.e. minimum wage) is below it. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 9

How Price Floors Affect Market Outcomes labor surplus 노동잉여 The eq’m wage($4) is below the floor and therefore illegal. 균형임금 $4는 가격하한 보다 낮으므로 불법이다 The floor is a binding constraint on the wage, causes a surplus (i.e., unemployment). 가격하한은 임금을 구속하여 노동잉여(실업)을 발생시킨다 W L S Price floor 가격 하한 $5 D 400 550 $4 Now, the minimum wage exceeds the equilibrium wage. The equilibrium wage (or any wage below $5) is illegal. In this case, the actual wage will be $5. It will not be lower, because any lower wage is illegal. It will not be higher, because at any higher wage, the surplus would be even greater. The actual number of unskilled workers with jobs equals 400. 550 want jobs, but firms are only willing to hire 400, leaving a surplus (i.e. unemployment) of 150 workers. A surplus of anything – especially labor – represents wasted resources. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 10

unemp-loyment W L S Min. wage $5 D 400 550 $4 The Minimum Wage 최저임금 Min wage laws do not affect highly skilled workers. 최저임금법은 숙련노동자에게는 영향을 주지 않는다 They do affect teen workers. 10대 미숙련 근로자에게 영향을 준다 Studies: A 10% increase in the min wage raises teen unemployment by 1-3%. 최저임금을 10% 인상하면 실업률은 1~3% 높아진다 unemp-loyment W L S Min. wage $5 D 400 550 $4 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 11

A C T I V E L E A R N I N G 1 Price controls Q P S The market for hotel rooms 호텔객실 시장 D Determine effects of: A. $90 price ceiling B. $90 price floor C. $120 price floor A good exercise to break up the lecture, engage students, and assess their learning so far. 12

A C T I V E L E A R N I N G 1 A. $90 price ceiling Q P S The market for hotel rooms D The price falls to $90. 객실료는 $90로 떨어진다 Buyers demand 120 rooms, sellers supply 90, leaving a shortage. 구매자는 120 객실을 원하는데, 판매자는 90실을 공급하여 부족 발생 Price ceiling shortage = 30 13

A C T I V E L E A R N I N G 1 B. $90 price floor Q P S The market for hotel rooms D Eq’m price is above the floor, so floor is not binding. P = $100, Q = 100 rooms. Price floor 14

A C T I V E L E A R N I N G 1 C. $120 price floor Q P S The market for hotel rooms D The price rises to $120. Buyers demand 60 rooms, sellers supply 120, causing a surplus. 가격은 $120로 오른다. 구매자는 60실을 원하는데, 판매자는 120실을 공급하여 잉여를 발생시킨다 surplus = 60 Price floor 15

Evaluating Price Controls 가격통제 평가 Recall one of the Ten Principles from Chapter 1: Markets are usually a good way to organize economic activity. 1장의 10가지 원칙 중 하나를 생각하자: 시장은 대개 경제 활동을 조직하는 좋은 방식이다. Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices. 가격은 사회적 자원 배분을 유도하는 신호이다. 정책입안자가 가격을 제한할 때 이런 가격의 배분 기능은 변화한다(제 역할 못함) Price controls often intended to help the poor, but often hurt more than help. 가격통제는 종종 저소득층을 돕고자 도입된다. 그러나 종종 도움보다는 더 피해를 주곤 한다. RE: the last bullet “price controls often hurt the poor more than help them.” We have seen that the minimum wage can cause job losses, and rent control can reduce the quantity and quality of affordable housing. Both policies make the poor worse off. It might be worth reminding students that our analysis has been in the context of a world without market failures. Subsequent chapters (except in the macro split) will introduce situations in which government intervention can improve on the private market outcome. However, even in such cases, the appropriate policy is usually something other than a direct price control. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 16

Taxes 조세 The govt levies taxes on many goods & services to raise revenue to pay for national defense, public schools, etc. 정부는 국방비, 공립학교 운영에 필요한 재원마련을 위해 많은 재화와 서비스에 세금을 부과한다 The govt can make buyers or sellers pay the tax. 정부는 구매자나 판매자에게 세금을 내도록 할 수 있다 The tax can be a % of the good’s price, or a specific amount for each unit sold. 세금은 재화 가격의 몇%(정률세) 또는 개당 정해진 금액(정액세)으로 부과 For simplicity, we analyze per-unit taxes only. 편의상 단순하게, 우리는 개당 부과되는 세금(정액세)을 분석한다 The slides in this section have been revised from the previous edition. They now better explain why a tax on buyers shifts D down by the amount of the tax, and why a tax on sellers shifts S up by the amount of the tax. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 17

EXAMPLE 3: The Market for Pizza Eq’m w/o tax 과세 없을 때의 균형 P Q D1 S1 $10.00 500 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 18

A Tax on Buyers 구매자에 대해 과세 Hence, a tax on buyers shifts the D curve down by the amount of the tax. 구매자에 대한 과세로 수요곡선은 세금액만큼 아래로 이동 The price buyers pay is now $1.50 higher than the market price P. 이제 구매자가 지불하는 가격은 $1.50 높아진다 P would have to fall by $1.50 to make buyers willing to buy same Q as before. 구입자들이 세금부과 이전과 동일한 양을 구입하도록 하려면 가격은 $1.50가 내려가야 한다 E.g., if P falls from $10.00 to $8.50, buyers still willing to purchase 500 pizzas. 가격이 $8.50가 되면 구입자는 여전히 500개를 구입하려 한다 Effects of a $1.50 per unit tax on buyers 구매자에게 개당 $1.50 과세 P Q D1 S1 D2 $10.00 500 Tax $8.50 NOTE: On this and subsequent slides, “PB” denotes the price buyers pay and “PS” denotes the price sellers receive. (The Chapter 8 PowerPoint uses the same notation for the welfare analysis of taxes.) The government makes buyers pay a $1.50 on each pizza they purchase. The new demand curve (in red, labeled D2) reflects buyers’ demand as a function of the after-tax price. The original demand curve (D1) still reflects buyers’ demand as a function of the total price – inclusive of the tax. Thus, buyers’ demand hasn’t really changed: at each quantity, the height of the original (blue) D curve is still the maximum that buyers will pay for that quantity, while the height of the new (red) D curve is the maximum that buyers will pay sellers for that quantity, given that buyers also must pay the tax. At any Q, the vertical distance between the blue and red D curves equals the tax. (If this were a percentage tax rather than a per-unit tax, the new D curve would not be parallel to the old one, it would be flatter: a tax of a given percentage would be a larger dollar amount at high prices than at low prices, so the downward shift would be greater in absolute terms when P is high than when it is low. This is the type of complexity we avoid by working with per-unit taxes.) SUPPLY, DEMAND, AND GOVERNMENT POLICIES 19

Effects of a $1.50 per unit tax on buyers A Tax on Buyers New eq’m: Q = 450 Sellers receive PS = $9.50 Buyers pay PB = $11.00 Difference between them = $1.50 = tax Effects of a $1.50 per unit tax on buyers P Q D1 S1 $11.00 PB = D2 Tax $10.00 500 $9.50 PS = 450 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 20

The Incidence of a Tax (조세의 귀착, 조세의 부담): how the burden of a tax is shared among market participants 시장 참가자들에게 세금의 부담이 어떻게 나뉘어지는가? P Q In our example, buyers pay $1.00 more, 구매자는 $1 더 내고, sellers get $0.50 less. 판매자는 $0.50 덜 받는다 D1 S1 $11.00 PB = D2 Tax 450 $10.00 500 $9.50 PS = “Market participants” simply means buyers and sellers. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 21

A Tax on Sellers 판매자에게 과세 Effects of a $1.50 per unit tax on sellers 판매자에 대해 $1.50 과세 The tax effectively raises sellers’ costs by $1.50 per pizza. 과세는 판매자 비용을 개당 $1.50 높인다 Sellers will supply 500 pizzas only if P rises to $11.50, to compensate for this cost increase. 판매자는 비용증가를 보상받기 위해 가격이 $11.50로 올라야지만 500개를 공급할 것이다 P Q S2 $11.50 D1 S1 Tax $10.00 500 The government makes sellers pay a $1.50 on each pizza they sell. The new, red supply curve reflects sellers’ supply as a function of the after-tax price. Hence, a tax on sellers shifts the S curve up by the amount of the tax. 그러므로 판매자에 대한 과세는 공급곡선을 세금액 만큼 위로 이동시킨다 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 22

Effects of a $1.50 per unit tax on sellers A Tax on Sellers New eq’m: Q = 450 Buyers pay PB = $11.00 Sellers receive PS = $9.50 Difference between them = $1.50 = tax Effects of a $1.50 per unit tax on sellers P Q S2 D1 S1 $11.00 PB = 450 Tax $10.00 500 $9.50 PS = SUPPLY, DEMAND, AND GOVERNMENT POLICIES 23

The Outcome Is the Same in Both Cases! 두 경우 결과는 동일 The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers! 세금이 구매자에게 부과되든 판매자에게 부과되든 조세의 귀착(부담)과 가격과 거래량은 동일하다 P Q What matters is this(중요한 것은 이것): A tax drives a wedge between the price buyers pay and the price sellers receive. 과세는 구매자가 지불하는 가격과 판매자가 받는 가격 사이의 차이를 벌여 놓는다. wedge(쐐기) D1 S1 PB = $11.00 Tax $10.00 500 PS = $9.50 Whether the government makes buyers or sellers pay the tax, all of the effects are the same: - the price buyers pay rises (in this case to $11) - the price sellers receive falls (to $9.50) - the equilibrium quantity falls (to 450) - the incidence of the tax is the same (here, buyers pay $1 of the tax, while sellers pay $.50 of the tax on each unit) This should make sense if students think it through: A tax on buyers means buyers will have to pay more, which causes their demand to fall. The fall in demand hurts sellers, forcing them to reduce their price. Similarly, a tax on sellers is like a cost increase, and sellers pass along a portion of that increase to buyers in the form of higher prices. The equivalence of taxes on buyers and taxes on sellers means that we can ignore whether the tax is imposed on buyers or sellers. All that matters is the size of the tax. So, in future problems, we can think of the tax as a wedge between the price buyers pay and the price sellers receive. On a supply-demand diagram, this wedge is a vertical line segment (shown in green on this graph). You can think of taking a toothpick the size of the tax and wedging it between the S and D curves. The quantity at which the toothpick fits just snuggly is the new equilibrium quantity. Students will have a chance to practice this in a moment with an exercise. One last remark: Someone once said “if you want less of something, tax it.” A tax on any good or service causes a fall in its quantity. This is because people respond to incentives: the tax gives buyers an incentive to buy less and gives sellers an incentive to produce less. 450 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 24

A C T I V E L E A R N I N G 2 Effects of a tax Q P S The market for hotel rooms D Suppose govt imposes a tax on buyers of $30 per room. 정부가 객실 당 $30씩 구매자에게 과세 Find new Q, PB, PS, and incidence of tax. 새로운 구매자 지불가격, 판매자 수취가격, 조세귀착은? These are the same supply and demand curves used in the previous exercise.

A C T I V E L E A R N I N G 2 Answers Q P S The market for hotel rooms D Q = 80 PB = $110 PB = Tax PS = $80 PS = Incidence buyers: $10 sellers: $20 First, the equilibrium quantity is the quantity where PB – PS = $30. This quantity is 80. Next, to find PB, start at Q=80 and go up to the demand curve to see that PB = $110. To find PS, start at Q=80 and go up to the supply curve to see that PS = $80. To find incidence, just compare PB and PS to the no-tax equilibrium price, $100.

Elasticity and Tax Incidence 탄력성과 조세부담 CASE 1: Supply is more elastic than demand (공급이 수요보다 탄력적일 때, 즉 수요 비탄력,, 공급 탄력) It’s easier for sellers than buyers to leave the market. 구매자보다 판매자가 시장을 떠나기 쉽다 So buyers bear most of the burden of the tax. 그러므로 구매자들이 세금의 대부분을 부담한다 P Q D PB S Buyers’ share of tax burden Tax Price if no tax Sellers’ share of tax burden PS We have just seen that tax incidence is not affected by whether the government makes buyers or sellers pay the tax. So what, then, does determine tax incidence? Turns out it’s elasticity – specifically, the price elasticities of supply and demand. There are two cases: 1) supply is more price-elastic than demand (this slide), and 2) demand is more price-elastic than supply (next slide). When supply is more price-elastic than demand, sellers are relatively more responsive to changes in price, and the supply curve is less steep than the demand curve. Buyers have relatively fewer alternatives, so they have to “eat” most of the price increase caused by the imposition of the tax. As the textbook puts it, sellers can more easily leave the market in response to the tax than can buyers. Thus, buyers are stuck bearing most of the burden of the tax. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 27

Elasticity and Tax Incidence CASE 2: Demand is more elastic than supply 수요가 공급보다 더 탄력적일 때, 즉 수요 탄력, 공급 비탄력 It’s easier for buyers than sellers to leave the market. 구매자가 판매자보다 시장을 떠나기 쉽다 Sellers bear most of the burden of the tax. 그러므로 판매자가 대부분 세금을 부담한다 P Q S D Buyers’ share of tax burden PB Tax Price if no tax Sellers’ share of tax burden The size of the tax is the same in this diagram as in the one on the preceding slide. When demand is more price-elastic than supply, buyers are relatively more price-sensitive, and the demand curve is less steep than the supply curve. Buyers have relatively more alternatives, so they can avoid most of the tax. Sellers are less flexible, so they have to “eat” a greater share of the price increase caused by the tax. From the textbook: Buyers can more easily leave the market than sellers in response to the tax. Thus, sellers end up with most of the burden of the tax. PS SUPPLY, DEMAND, AND GOVERNMENT POLICIES 28

CASE STUDY: Who Pays the Luxury Tax? 1990: Congress adopted a luxury tax on yachts, private airplanes, furs, expensive cars, etc. Goal of the tax: raise revenue from those who could most easily afford to pay – wealthy consumers. But who really pays this tax? This case study shows students an interesting real-world example of the material they just learned. If you’re pressed for time, it is probably safe to skip it and let students read it on their own. It does not introduce any new concepts, and most students do not find it difficult to read. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 29

CASE STUDY: Who Pays the Luxury Tax? The market for yachts Demand is price-elastic. P Q S In the short run, supply is inelastic. D Buyers’ share of tax burden PB Tax Hence, companies that build yachts pay most of the tax. Sellers’ share of tax burden Demand for yachts (and other luxury items) is price-elastic: if the price of yachts rises, rich consumers can easily avoid the tax by spending their millions on some other luxury item. Supply of yachts is less elastic, especially in the short run. It is difficult for the companies that build yachts to re-tool their factories and reeducate their workers to produce some other product. Hence, companies that build yachts pay most of the tax, and the rich pay relatively little of it. The same is true for taxes on other luxury items. PS SUPPLY, DEMAND, AND GOVERNMENT POLICIES 30

CONCLUSION: Government Policies and the Allocation of Resources Each of the policies in this chapter affects the allocation of society’s resources. Example 1: A tax on pizza reduces eq’m Q. With less production of pizza, resources (workers, ovens, cheese) will become available to other industries. Example 2: A binding minimum wage causes a surplus of workers, a waste of resources. So, it’s important for policymakers to apply such policies very carefully. Recall one of the 10 principles from Chapter 1: Markets are usually a good way to organize economic activity. This means that, in absence of market failures (which we will learn more about in later chapters), the allocation of resources resulting from the free market equilibrium is optimal. Hence, government policies which alter this allocation tend to make the economy worse off. When we study market failures later, we will see that government policies can – in principle – improve on the market’s allocation of resources, and make society better off. First, though, we need to learn how to measure the impact of government policies like taxes on society’s well-being, as well as define what, exactly, we mean by “well-being.” This field of study, called “welfare economics,” is the topic of the following three chapters. SUPPLY, DEMAND, AND GOVERNMENT POLICIES 31

CHAPTER SUMMARY A price ceiling is a legal maximum on the price of a good. An example is rent control. If the price ceiling is below the eq’m price, it is binding and causes a shortage. A price floor is a legal minimum on the price of a good. An example is the minimum wage. If the price floor is above the eq’m price, it is binding and causes a surplus. The labor surplus caused by the minimum wage is unemployment. 32

CHAPTER SUMMARY A tax on a good places a wedge between the price buyers pay and the price sellers receive, and causes the eq’m quantity to fall, whether the tax is imposed on buyers or sellers. The incidence of a tax is the division of the burden of the tax between buyers and sellers, and does not depend on whether the tax is imposed on buyers or sellers. 조세의 귀착은 구매자와 판매자 사이에 세금의 부담을 나눈다. 이는 과세가 판매자에게 부과되든 구매자에게 부과되든 상관없다. The incidence of the tax depends on the price elasticities of supply and demand. 조세의 귀착(부담)은 수요와 공급의 가격 탄력성에 좌우된다. 33