Supply, Demand and Government Policies

JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.

Supply, Demand, and Government Policies In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. One of the things government can do is to set price controls when the market price is seen as unfair to either buyers or sellers. 2 2

Price Ceilings & Price Floors A legally established maximum price at which a good can be sold. (Rent Controls) Price Floor A legally established minimum price at which a good can be sold. (Price Supports for Agriculture) 4 4

Price Ceilings Two outcomes are possible when the government imposes a price ceiling:  The price ceiling is not binding if set above the equilibrium price. The price ceiling is binding if set below the equilibrium price, leading to a shortage. Binding means that there is an economic impact. 5 5

A Price Ceiling That Is Binding... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Price Ceiling That Is Binding... Price of Ice-Cream Cone Supply Equilibrium price $3 2 Price ceiling 75 Quantity supplied 125 Quantity demanded Shortage Demand Quantity of Ice-Cream Cones 7 10

A Price Ceiling That Is Not Binding... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Price Ceiling That Is Not Binding... Price of Ice-Cream Cone Supply $4 Price ceiling 3 Equilibrium price Demand 100 Quantity of Ice-Cream Cones Equilibrium quantity 6 7

Effects of Price Ceilings A binding price ceiling creates ... shortages because QD > QS. Example: Gasoline shortage of the 1970s nonprice rationing Examples: Long lines, Discrimination by sellers 11 14

The Price Ceiling on Gasoline Is Not Binding... Price of Gasoline 1. Initially, the price ceiling is not binding... Supply $4 Price ceiling P1 Demand Quantity of Gasoline Q1 6 7

The Price Ceiling on Gasoline Is Binding... Price of Gasoline 2. …but when supply falls... S1 P2 Price ceiling 4. …resulting in a shortage. 3. …the price ceiling becomes binding... P1 Demand Quantity of Gasoline Q1 6 7

Rent Control Rent controls are ceilings placed on the rents that landlords may charge their tenants. Rent control can make housing more affordable. With a price ceiling, you cannot go above the ceiling. But what about the landlords? 2

Rent Control in the Short Run... Rental Price of Apartment Supply and demand for apartments are relatively inelastic-Why is the supply curve vertical? Supply Controlled rent Shortage Demand Quantity of Apartments 7 10

Rent Control in the Long Run... Because the supply and demand for apartments are more elastic... What happens in the long run? Rental Price of Apartment Supply …rent control causes a large shortage Controlled rent Shortage Demand Quantity of Apartments 7 10

Price Floors When the government imposes a price floor, two outcomes are possible. The price floor is not binding if set below the equilibrium price. The price floor is binding if set above the equilibrium price, leading to a surplus. Think of price floors as not being able to go below the floor. 12 15

A Price Floor That Is Not Binding... Price of Ice-Cream Cone Supply Equilibrium price $3 Price floor 2 Demand 100 Quantity of Ice-Cream Cones Equilibrium quantity 8 17

A Price Floor That Is Binding... Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc. A Price Floor That Is Binding... Price of Ice-Cream Cone Supply Surplus $4 Price floor 80 Quantity demanded 120 Quantity supplied $3 Equilibrium price Demand Quantity of Ice-Cream Cones 8 17

Effects of a Price Floor A binding price floor causes . . . a surplus because QS >QD. nonprice rationing is an alternative mechanism for rationing the good, using discrimination criteria. Examples: The minimum wage, Agricultural price supports State Minimum Wages 15 25

The Minimum Wage A Free Labor Market Labor supply Labor demand Wage Equilibrium wage Equilibrium employment Labor demand Quantity of Labor

A Labor Market with a Minimum Wage The Minimum Wage A Labor Market with a Minimum Wage Wage Labor supply Labor surplus (unemployment) Minimum wage Quantity demanded Quantity supplied Labor demand Quantity of Labor

What are some potential impacts of taxes? Taxes are used to raise money for the government. Taxes discourage market activity. When a good is taxed, the quantity sold is smaller. Buyers and sellers share the tax burden. But who bears the burden-tax incidence. 22 30

Impact of a 50¢ Tax Levied on Buyers... Copyright © 2001 by Harcourt, Inc. All rights reserved Impact of a 50¢ Tax Levied on Buyers... Price of Ice-Cream Cone Supply, S1 $3.30 Price buyers pay Equilibrium without tax Tax ($0.50) Price without tax 3.00 2.80 Price sellers receive Equilibrium with tax This has always been difficult to measure, usually easier to look at the shift in supply as opposed to demand. Think of it this way, if the tax is on the buyer for every ice cream cone paid, the buyer will give $2.80 to the ice cream shop and $.50 to the government. So the demand curve shifts to the left, find the price that the producer receives (can make this up!) and then count $.50 up to the old demand curve, this will be the ultimate price the buyer will pay to both the ice cream shop and to the government. D1 D2 90 100 Quantity of Ice-Cream Cones 38 23

Impact of a 50¢ Tax on Sellers... Copyright © 2001 by Harcourt, Inc. All rights reserved Impact of a 50¢ Tax on Sellers... Price of Ice-Cream Cone A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50). $3.30 Price buyers pay S2 Equilibrium with tax S1 90 Tax ($0.50) 3.00 Price without tax Equilibrium without tax 2.80 Price sellers receive A 50 cent tax has an equal effect whether the tax is on buyers or sellers. In this case, the tax is on the seller and the tax is passed on partially to the buyer in the form of a higher price than before the tax and partially to the seller in terms of a lower price received than otherwise than before the tax. Demand, D1 100 Quantity of Ice-Cream Cones

The Incidence of Tax In what proportions is the burden of the tax divided? How do the effects of taxes on sellers compare to those levied on buyers? The answers to these questions depend on the elasticity of demand and the elasticity of supply. 29 39

Elastic Supply, Inelastic Demand... Price 1. When supply is more elastic than demand... Price buyers pay Tax 2. ...the incidence of the tax falls more heavily on consumers... Supply Price without tax 3. ...than on producers. Which curve shifted is not drawn as the analysis would be the same anyway. Would be a good idea to draw the different shifts to show that it does reach the same result. Can really see the impact if demand is perfectly inelastic or perfectly elastic. Price sellers receive Demand Quantity 44 32

Inelastic Supply, Elastic Demand... 1. When demand is more elastic than supply... Price Supply Price buyers pay Tax 3. ...than on consumers. Price without tax 2. ...the incidence of the tax falls more heavily on producers... Demand Price sellers receive Quantity 32 51

JOIN KHALID AZIZ ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.