Supply Demand and Government Policies

conomists have two roles- As scientists, they develop and test theories to explain the world around them. As policy advisers, they use their theories to help change the world for tlx- better. The- focus ot" the preceding two chapters has been scientific. We have seen how supply and demand determine the price of a good and the quantity of the good sold We have also seen how various events shift supply and demand and thereby change the equilibrium price and

This chapter offers our first look at policy. Here we analyze various types of government policy using only the tools of supply and demand. As you will see, the analysis yields some surprising insights. Policies often have effects that their architects did not intend or anticipate.

We begin by considering policies that directly control prices. For example, rent-control laws dictate a maximum rent that landlords may charge tenants. Minimum-wage laws dictate the lowest wage firms may pay workers. Price control»are usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers Yet, as we will see, these policies can generate inequities of their own.


After discussing price controls, we consider the impact of taxes. Policymakers use taxes to raise revenue for public purposes and to influence market outcomes. Although the prevalence of taxes in our economy is obvious, their effects are not. For example, when the government levies a tax on the amount that firms pay their workers, do the firms or the workers bear the burden of the tax? The answer is not at all dear—until we apply the powerful tools of supply and demand.

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