1. Supply, Demand and Government Policies

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3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

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

16. 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

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

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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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:
R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA, KARACHI, PAKISTAN.