Applications of Demand and Supply Topic 3

So far… Demand & Supply Equilibrium determined by market forces Equilibrium maintained by market forces

Price Controls Some cases market forces are not allowed to determine equilibrium price and quantity Intervention by authorities (Govt.) Price Ceilings Price Floors Taxes on Producers on Consumers

fig P Q O PePe S D Maximum price A price ceiling is the maximum legal price a seller may charge for a good or service (Jackson page 160)

Price Ceilings Govt. sets the price LOWER than the equilibrium. Why would they do this? What is the result? Who benefits? Who loses? What is likely to happen?

Why would they do it? To keep the price down to an acceptable level. During wartime price controls may be imposed on essential items such as petrol, rice etc. To help the poor & the disadvantaged

fig P QO PePe QdQd QsQs S D shortage maximum price What are the results?

What are likely to happen? Effects: dealing with resulting shortages => rationing black markets

fig P Q O PbPb PgPg PePe QsQs QdQd D S Effect of price control on black- market prices Price ceiling Blackmarketeers profits

Gainers & Losers? Gainers Consumers who are able to obtain supplies at the price ceiling Losers: Consumers who cannot obtain supplies (even though they are willing to purchase at the equilibrium price )

Price Controls- Consumer Surplus & Producer Surplus Originally CS = A+B PS = C+E+F After Price ceiling CS = A+C PS = F What about B & E? net loss in total surplus

Price Floors A price floor is the minimum price set by the govt for a good or service Govt. sets the price floor HIGHER than the equilibrium Why would they do this? What is the result? Who benefits? Who loses? What is likely to happen?

Why does the government do it? To support prices (income) in important sectors of the economy (eg. Agriculture). To protect workers (eg. minimum wages)

fig P QO PePe minimum price QdQd QsQs S D surplus What is the impact?

Gainers & Losers? Gainers Suppliers who receive higher price per unit and probably, higher income. Workers who are in job receive a higher wage Losers: Consumers who have to pay higher prices for the goods. Workers who were previously working, are now unemployed

Price Controls, CS & PS (contd.) Originally CS = A+B+C PS = E+F After Price floor CS = A PS = C+F What about B & E? net loss in total surplus

Taxes on Producers Supply curve shifts up vertical shift = amount of tax Equilibrium price increases, equilibrium quantity decreases Notice the difference in amount of tax and increase in price. As elasticity of demand and supply vary, the burden changes

Taxes on Producers Effects of imposing tax on producers: SoSo S1S1 Q P E0E0 E1E1 Q0Q0 Q1Q1 Consumers tax burden Tax D Consumers tax burden > Producers tax burden if Demand is relatively inelastic Producers tax burden

Taxes on Producers

Taxes on producers

Taxes on Producers

Taxes on Consumers Demand curve shifts down vertical shift = amount of tax Equilibrium price decreases, equilibrium quantity decreases Notice the difference in amount of tax and decrease in price. As elasticity of demand and supply vary, the burden changes

Elasticity and Tax burden - Summary ElasticInelastic DemandProducerConsumer SupplyConsumerProducer So, the burden of tax is not affected by who it is levied on (producer or consumer). It is affected by the elasticities of demand & supply