Unit 2: Supply, Demand, and Consumer Choice

REMEMBER THE STEPS!

Government Involvement #1-Price Controls: Floors and Ceilings #2-Import Quotas #3-Subsidies #4-Excise Taxes

#1-PRICE CONTROLS Who likes the idea of having a price ceiling on gas so prices will never go over $1 per gallon?

Price Ceiling Gasoline Maximum legal price a seller can charge for a product. Goal: Make affordable by keeping price from reaching Eq. P Gasoline S $5 4 3 2 1 Does this policy help consumers? Result: BLACK MARKETS Price Ceiling Shortage (Qd>Qs) D o 10 20 30 40 50 60 70 80 Q 5

To have an effect, a price ceiling must be below equilibrium

Price Floor Corn Minimum legal price a seller can sell a product. Goal: Keep price high by keeping price from falling to Eq. P Corn S $ 4 3 2 1 Surplus (Qd<Qs) Price Floor Does this policy help corn producers? D o 10 20 30 40 50 60 70 80 Q 7

To have an effect, a price floor must be above equilibrium

Practice Questions 1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium? Surpluses will develop Shortages will develop Underground markets will develop The equilibrium price will remain the same The quantity sold will increase 2. Which of the following statements about price control is true? A. A price ceiling causes a shortage if the ceiling price is above the equilibrium price B. A price floor causes a surplus if the price floor is below the equilibrium price C. Price ceilings and price floors result in a misallocation of resources D. Price floors above equilibrium cause a shortage Answers: D C

Answer the Questions below then draw the graphs requested in your notes: In your notes: draw one S&D graph that shows a price floor and another that shows a price ceiling

Are Price Controls Good or Bad? To be “efficient” a market must maximize consumers and producers surplus P S CS Pc PS D Qe Q

Are Price Controls Good or Bad? DEADWEIGHT LOSS The Lost CS and PS. To be “efficient” a market must maximize consumers and producers surplus P S CS Price FLOOR DEADWEIGHT LOSS The Lost CS and PS. INEFFICIENT! Pc PS D Qfloor Qe Q

Are Price Controls Good or Bad? To be “efficient” a market must maximize consumers and producers surplus P S CS Pc PS D Qe Q

Are Price Controls Good or Bad? DEADWEIGHT LOSS The Lost CS and PS. To be “efficient” a market must maximize consumers and producers surplus P S DEADWEIGHT LOSS The Lost CS and PS. INEFFICIENT! CS Pc Price CEILING PS D Qceiling Qe Q

#2 Import Quotas A quota is a limit on number of imports. The government sets the maximum amount that can come in the country. Purpose: To protect domestic producers from a cheaper world price. To prevent domestic unemployment

International Trade and Quotas Identify the following: CS with no trade PS with no trade CS if we trade at world price (PW) PS if we trade at world price (PW) Amount we import at world price (PW) If the government sets a quota on imports of Q4 - Q2, what happens to CS and PS? 1.H 2.TLI 3.HIJKLMNRS 4.T 5.Q5-Q1 6. CS gets smaller and PS gets bigger This graphs show the domestic supply and demand for grain. The letters represent area.

Ai - P2 Aii - Q2 B – Q3-Q1 Ci – P2KG Cii – KHPw Di – P1 P2 G Dii – Pw P1 J

#3 Subsidies The government just gives producers money. The goal is for them to make more of the goods that the government thinks are important. Ex: Agriculture (to prevent famine) Pharmaceutical Companies Environmentally Safe Vehicles FAFSA

Result of Subsidies to Corn Producers Price of Corn S SSubsidy Price Down Quantity Up Everyone Wins, Right? Pe P1 D o Qe Q1 Q Quantity of Corn 19

Excise Tax = A per unit tax on producers #4 Excise Taxes Excise Tax = A per unit tax on producers For every unit made, the producer must pay $ NOT a Lump Sum (one time only)Tax The goal is for them to make less of the goods that the government deems dangerous or unwanted. Ex: Cigarettes “sin tax” Alcohol “sin tax” Tariffs on imported goods Environmentally Unsafe Products Etc. 21

Government sets a $2 per unit tax on Cigarettes Excise Taxes Supply Schedule Government sets a $2 per unit tax on Cigarettes P P Qs $5 140 $4 120 $3 100 $2 80 $1 60 S $5 4 3 2 1 D o Q 22 40 60 80 100 120 140

Government sets a $2 per unit tax on Cigarettes Excise Taxes Supply Schedule Government sets a $2 per unit tax on Cigarettes P P Qs $5 $7 140 $4 $6 120 $3 $5 100 $2 $4 80 $1 $3 60 S $5 4 3 2 1 D o Q 23 40 60 80 100 120 140

Tax is the vertical distance between supply curves Excise Taxes STax Supply Schedule P P Qs $5 $7 140 $4 $6 120 $3 $5 100 $2 $4 80 $1 $3 60 S $5 4 3 2 1 Tax is the vertical distance between supply curves D o Q 24 40 60 80 100 120 140

Identify the following: Excise Taxes S Identify the following: Price before tax Price consumers pay after tax Price producers get after tax Total tax revenue for the government before tax Total tax revenue for the government after tax P S $5 4 3 2 1 1.$3 2.$4 3.$2 4.$0 5.$160 D o Q 25 40 60 80 100 120 140

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Tax Practice CS Before Tax PS Before Tax CS After Tax PS After Tax Tax Revenue for Government Dead Weight Loss due to tax Amount of tax revenue producers pay 1.ABCD 2.HFEG 3.A 4.G 5.BCHF 6.DE 7.HF 27

Excise Tax P $14 12 11 8 S D 10 12 Q

Excise Tax 12 P Stax S $14 11 Pc 8 Pp D 12 10 Q Calculate Tax Per Unit Total Tax Revenue Amount of Tax paid by consumers Amount of Tax paid by producers Total Expenditures Total Revenue for firms P Stax $14 12 11 8 S Pc Pp D 10 12 Q

Excise Tax Calculate CS Before Tax Total Expenditures Before Tax Tax Per Unit Total Tax Revenue that goes to Government Amount of Tax paid by consumers Amount of Tax paid by producers Total Expenditures after tax Total Revenue for firms after tax CS After Tax DWL