PRICE CONTROLS THE PRICE IS NOT FREE TO AUTOMATICALLY MOVE BACK TO EQUILIBRIUM

GOVERNMENT INTERVENTION Sometimes the government will intervene in a market to determine the price as the outcome could be seen as unfair (to consumers- too high, or producers- too low). E.g. Minimum wage (currently at $12.50)

MINIMUM PRICE (FLOOR PRICE) Sometimes a minimum price is set in a market above the equilibrium as it is seen as being unfair to the suppliers in that particular market. In a market where there are a combination of very high and very low prices, a minimum price may be set which it cannot fall below. This price must be above equilibrium to be effective.

S D Minimum price QeQe PePe Qs Qd Price ($) Quantity (units) surplus As a result of the new minimum price (above equilibrium) a surplus has now been created.

MAXIMUM PRICE (CEILING PRICE) Maximum prices are used to protect our consumers from having to pay ridiculously high prices for certain goods and services. Usually placed on Merit Goods. A maximum price will be set below equilibrium, otherwise it will not be effective.

S D Maximum price QeQe PePe Qd Qs Price ($) Quantity (units) shortage As a result of the new maximum price (below equilibrium) a shortage has now been created.

TAXES AND SUBSIDIES

DIRECT TAXES Tax on income and earnings. E.g. Income tax. If direct taxes are increased this will reduce people’s disposable income shifting the demand curve to the left. Price ($) Quantity (units) S D1 D2 Q1 P1 P2 Q2

INDIRECT TAXES A tax on consumption or spending. E.g. GST. An indirect tax will affect the supply curve Remember that GST is added on top of the price the seller will receive therefore will shift the supply curve UP (vertically) to reach this new price. Price ($) Quantity (units) S2 D S1 Q1 P1 Q2 P2

At the new price the difference between the original and new supply curves should reflect the tax, not the difference between the original and new equilibrium points (tax=$20, (70 -50) NOT $10). Price ($) Quantity (units) S2 D S The amount of the tax.

SUBSIDIES = payment to producers from government in order to reduce costs of production. Since subsidies effectively lower the costs of production supply will increase. (The supply curve moves DOWN vertically ) The vertical distance between the old supply curve and the new supply curve is the size of the subsidy Price ($) Quantity (units) S1 D S

The new equilibrium price is the price paid by consumers Producers receive this price plus the subsidy The producers have been paid a subsidy of $2 for every unit sold. Part of this has been passed onto the consumer through the decrease in equilibrium price, but not all the subsidy has been passed onto consumers as the price has only fallen by $1 ( from $12 to $11) Quantity (units) S1 D S Price ($)

KEY FORMULA – SUBSIDY Total Revenue = Price x Quantity Total revenue earned by producers before the subsidy ( use original equilibrium) TR = Price received X number of units sold Total Revenue earned by producers after the subsidy TR = Price received X number of units sold TR = New equilibrium price + Subsidy x number of units sold Total cost of subsidy to the government = Subsidy amount x number of units sold ( new quantity) Total spending by consumers after subsidy = Price paid x quantity bought Total expenditure by consumers + Total subsidy paid by govt = total revenue by producers

SALES TAXES ( INDIRECT TAXES) Indirect tax = A tax on consumption or spending e.g. GST ( Goods and Services Tax) Sales tax will affect supply as the tax effectively increases the producers costs of production. Therefore producers are willing to supply less which will cause supply curve to shift UP (vertically) to reach this new price Price ($) D S S with Tax $4 tax Pe1 Qe1 Pe Qe Example – Government places a $4 tax on Cigarettes Pp Quantity ( 000s)

SALES TAX The distance between the old and new supply curves is exactly the same amount of the tax Part of the sales tax has been passed on to the consumer through the increase in equilibrium price and part of the tax has been taken on by the producer. Price ($) D S S with Tax $4 tax Pe1 Qe1 Pe Qe Pp

Before the tax Consumers Paid =$14 ( Old Equilibrium price, Pe) Producers received= $14 ( Old Equilibrium price, Pe) Quantity sold = 8000 ( Old equilibrium Quantity, Qe) Price ($) D S S with Tax $4 tax Pe1 Qe1 Pe Qe After the tax Consumers Pay = $16 ( New Equilibrium price, Pe1) Producers receive = $12 ( consumers price – tax, Pp) Quantity sold = 6000 ( New Equilibrium Quantity, Qe1) Government Revenue = ( New Equilibrium quantity x tax amount) Pp Quantity ( 000s)