Copyright © 2005 Pearson Education Canada Inc.5-1 Chapter 5 Extensions of Demand, Supply, and Elasticity

Copyright © 2005 Pearson Education Canada Inc.5-2 Learning Objectives 5.1Explain the role of markets, intermediaries, and prices in the price system. 5.2Compare and contrast price ceiling and price floor policies. 5.3Compare and contrast the offer-to- purchase and the marketing board price support policies.

Copyright © 2005 Pearson Education Canada Inc.5-3 Learning Objectives 5.4Describe the various types of quantity restrictions that governments can impose on markets. 5.5Explain how price elasticity governs the effects that a per-unit excise tax has on tax incidence, resource allocation, and government tax revenue collected.

Copyright © 2005 Pearson Education Canada Inc.5-4 The Price System Price System (market system)  An economic system that allocates resources based on relative prices determined by supply and demand.  Prices signal what is relatively scarce and relatively abundant.

Copyright © 2005 Pearson Education Canada Inc.5-5 The Price System Transaction Costs  The costs associated with exchange.  Examples Price shopping Determining quality Determining reliability Service availability Cost of contracting

Copyright © 2005 Pearson Education Canada Inc.5-6 The Price System The Rationing Function of Prices When surpluses and shortages exist price adjusts to clear the market. This adjustment is the rationing function of price.

Copyright © 2005 Pearson Education Canada Inc.5-7 The Price System When prices cannot adjust non-price rationing occurs  Rationing by queues  Rationing by lotteries  Rationing by coupons  Rationing by waiting

Copyright © 2005 Pearson Education Canada Inc.5-8 Price Ceilings and Price Floors Price Controls  Government-mandated minimum or maximum prices. Price Ceiling  A legal maximum price. Price Floor  A legal minimum price.

Copyright © 2005 Pearson Education Canada Inc.5-9 Price Ceilings and Price Floors Price Ceilings: The Case of Rent Controls Price ceiling and black markets  Price ceilings may prevent the equilibrium price from being achieved if it is above the ceiling price.

Copyright © 2005 Pearson Education Canada Inc.5-10 Price Ceilings and Price Floors P e =$800 Quantity: Number of units per month Monthly Rent per Unit D S Q e 60,000 Black market $1000 Price Ceiling $650 Q S 50,000 Q D 70,000 Shortage Price Ceilings: The Case of Rent Controls

Copyright © 2005 Pearson Education Canada Inc.5-11 Price Ceilings and Price Floors Non-Price Rationing Devices  All methods used to ration scarce goods that are price-controlled. Black Market  A market in which price-controlled goods are sold at an illegally high price.

Copyright © 2005 Pearson Education Canada Inc.5-12 Price Ceilings and Price Floors The functions of equilibrium rental prices  Promotes the efficient maintenance and construction of housing  Allocates existing housing  Rations the use of housing

Copyright © 2005 Pearson Education Canada Inc.5-13 Price Ceilings and Price Floors Discourages the construction of new housing Effects on the existing supply of housing  Property owners cannot recover costs Rationing the current use of housing  Reduces mobility

Copyright © 2005 Pearson Education Canada Inc.5-14 Price Ceilings and Price Floors Attempts at evading rent controls  Forcing tenants to leave  Tenants subletting apartments  Housing courts

Copyright © 2005 Pearson Education Canada Inc.5-15 Price Ceilings and Price Floors Who gains and who loses from rent controls?  Losers Property owners Low-income individuals  Benefits Upper-income professionals

Copyright © 2005 Pearson Education Canada Inc.5-16 Price Ceilings and Price Floors Quantity of Labour per Time Period D S WeWe E QeQe Increase in quantity of labour supplied Excess quantity supplied at wage W m Reduction in quantity of labour demanded Wage Rate per Unit QdQd QsQs WmWm ABC 800 Unemployed

Copyright © 2005 Pearson Education Canada Inc.5-17 Price Supports: Offer to Purchase and Marketing Boards Price Supports: The Case of Agriculture Governments have implemented a variety of price support policies to combat lagging and variable farm income.

Copyright © 2005 Pearson Education Canada Inc.5-18 Price Supports: Offer to Purchase and Marketing Boards Offer to Purchase policy  A price floor policy reinforced by the purchase of surplus output by the government.  Consumers pay higher prices for the product, and taxpayers purchase excess surplus.

Copyright © 2005 Pearson Education Canada Inc.5-19 Price Supports: Offer to Purchase and Marketing Boards 14 Thousands of tonnes Price per tonne D S P e = $ A surplus of 3000 tonnes per year will result in order to keep the price at $ Price floor = $700 surplus

Copyright © 2005 Pearson Education Canada Inc.5-20 Price Supports: Offer to Purchase and Marketing Boards Marketing Boards  A policy which allows producers to band together to restrict total quantity supplied by using quotas.

Copyright © 2005 Pearson Education Canada Inc.5-21 Price Supports: Offer to Purchase and Marketing Boards Price will rise to $700 with imposition of a quota. Thousands of tonnes D S P e = $ Market Board price = $700 Price per tonne

Copyright © 2005 Pearson Education Canada Inc.5-22 Price Supports: Offer to Purchase and Marketing Boards Who loses?  Consumers pay more for the product.  New producers must pay for purchasing the quotas.  Foreign producers cannot export to Canada.

Copyright © 2005 Pearson Education Canada Inc.5-23 Quantity Restrictions Governments may also impose quantity restrictions on a product  Outright ban of a product  Government licensing requirements  Import quotas

Copyright © 2005 Pearson Education Canada Inc.5-24 Elasticity and Excise Taxes Excise Tax  A tax imposed on a particular commodity or service. E.g. gasoline, alcohol, cigarettes, hotel rooms Tax Incidence  The division of the burden of a tax between the buyer and seller.

Copyright © 2005 Pearson Education Canada Inc.5-25 Elasticity and Excise Taxes 14 Thousands of tonnes Price per carton D S1S $65 Supply will shift up by $15 with an excise tax of $15. S2S2 $50 $55 $70

Copyright © 2005 Pearson Education Canada Inc.5-26 Elasticity and Excise Taxes Elasticity and Tax Incidence  When demand is elastic, sellers will bear a greater portion of the tax burden.  When supply is inelastic, buyers will bear a greater portion of the tax burden.