1. “Who would be a leader must be a bridge” Colega Consulting Ltd Bridgend, Wales © Dr Charles Smith, Director

2. Applied micro-economics : simple tools for complex problems Dr Charles Smith Colega Consulting Ltd & University of Wales

3. Supply & Demand Analysis Remember: AS and A2 are SYNOPTIC. AS topics are not “finished with” at A2; they are built upon, and you have to step up a gear. Generally speaking S & D analysis … at AS deals with cases where market equilibrium is ACHIEVED … at A2 deals with cases where market equilibrium is PREVENTED

4. Equilibrium prevented: Maximum and minimum price controls I have deliberately used diagrams which, with practice, can be reproduced BY YOU under exam conditions. Often in economics, “a picture is worth a thousand words” - if it is used properly. Let’s look at a versatile diagram which we can use to help analyse some important economic issues, and answer a variety of exam questions.

5. Maximum and minimum price controls The diagram on this page looks complicated at first sight, but DON’T PANIC, because… S E PEPE P MIN P MAX O X Z S2S2 S1S1 D1D1 D2D2 W Y Q1Q1 Q1Q1 QEQE Q2Q2 PRICE QTY D you’ll rarely (probably never) need the whole diagram you can use a part of the diagram depending on the issue that you are discussing the crucial features are points w, x, y and z, which we will discuss in detail

6. Maximum price controls This diagram shows the effect of a CEILING PRICE or a MAXIMUM PRICE CONTROL. The maximum price is shown as the horizontal line P max QTY PRICE S E P MAX O Q1Q1 Q2Q2 D

7. Maximum price controls To avoid an excess demand of Q1Q2 the price fixing authority must EITHER Reduce demand OR Increase supply QTY PRICE S E P MAX O Q1Q1 Q2Q2 D

8. Maximum price controls In other words, the price fixing authority must EITHER Shift the demand curve to D1 (aim at equilibrium point ‘w’) OR Shift the supply curve to S1 (aim at equilibrium point ‘x’) Unless the authority can influence either supply or demand, the maximum price CANNOT be held and the market will revert to equilibrium point ‘E’ QTY S E P MAX O x D1D1 w Q1Q1 Q2Q2 PRICE D S1S1

9. Minimum price controls This diagram shows the effect of a FLOOR PRICE or a MINIMUM PRICE CONTROL. The minimum price is shown as the horizontal line P min QTY E P MIN O Q1Q1 Q2Q2 PRICE D S

10. Minimum price controls To avoid an excess supply of Q1Q2 the price fixing authority must EITHER increase demand OR reduce supply QTY E P MIN O Q1Q1 Q2Q2 PRICE D S

11. Minimum price controls In other words, the price fixing authority must EITHER Shift the demand curve to D2 (aim at equilibrium point ‘y’) OR Shift the supply curve to S2 (aim at equilibrium point ‘z’) Unless the authority can influence either supply or demand, the minimum price CANNOT be held and the market will revert to equilibrium point ‘E’ QTY S E P MIN O y D2D2 z Q1Q1 Q2Q2 PRICE D S2S2

12. Table of outcomes New equil- ibrium point Price, compared with market equil- ibrium Quantity, compared with market equil- ibrium wlowerlower xlowerhigher yhigherhigher zhigherlower ALL POSSIBILITIES ARE EXHAUSTED S E PEPE P MIN P MAX O x z S2S2 S1S1 D1D1 D2D2 w y Q1Q1 Q1Q1 QEQE Q2Q2 PRICE QTY D

13. New equil. point Price, compared with market equil- ibrium Qty. compared with market equil- ibrium EXAMPLE(S)METHOD(S) wlower Rationing Ration books, Queues, etc xlowerhigherMerit goodsSubsidy yhigher Buffer stocks Intervention buying zhigherlower De-merit goodsTax

14. Problem: Traffic congestion

15. Road-space strategies EXCESS DEMAND AT ZERO PRICE E S Qty Price D QE Q1 O THE MARKET FOR ROAD-SPACE

16. Road-space strategies (continued) S QTY PRICE D QE Q1 O POLICY OPTIONS F G S1 D1 D2 PE E S2

17. Road pricing : key issues Negative externalities Road traffic a demerit good Elasticities Alternatives (eg public transport) needed for a substitution effect to take place Public vs. private transport Average versus marginal prices Decisions made on the margin are generally better than decisions based on averages Political will

18. Problem: Side effects of tobacco, sugar and alcohol consumption (“externalties”)

19. Tobacco & alcohol are already heavily taxed & regulated. New proposals: –A tax an sugary drinks; –A minimum price for alcoholic drinks. WHY a tax on one but minimum price on the other?

20. Minimum price controls QTY E P MIN O Q 1 Q2Q2 PRICE D S Z Y

21. Minimum price controls SHIFT OR MOVEMENT ALONG? A TAX aims to reach point Z by shifting the supply curve to the left (the tax in effect raises the costs of production) A MINIMUM PRICE aims to reach point Z by imposing a price on consumers which causes them to MOVE ALONG their demand curve from E to Z QTY E P MIN O Q1Q1 Q2Q2 PRICE D S Z S2 NEITHER does what arguably really needs to be done, which is shift the demand curve to the left. To do this, it would be necessary to influence consumer tastes and preferences, e.g. through education – a long term process

22. Possible matters to consider: * Elasticities; impact and incidence of indirect taxes * Legislation – raising minimum age, banning * Grey markets and smuggling, need for POLICING of policies * Education linking in to time lags * Negative externalities as to reasons why the government might want to intervene. *Government failure… How do they know the right minimum price, or the correct level of tax *Asymmetric information. *Impact on jobs etc for the industry * Distributional issues (effects on rich & poor)

23. Particularly evaluative points… Minimum price gives a windfall to producers; taxes give a windfall to the government, depending on price elasticities of demand AND supply Is the ideal state ZERO consumption? In which case there is NO windfall for anyone (and possibly no industry!) Nanny state verses freedom of choice Impact of policies on different groups: producers/ consumers, exporters/ importers, manufacturers/ service providers, taxpayers/ government, etc etc Are minimum prices considered (by politicians) easier to get away with than taxes?

24. Further reading: Smith, Smith & Etherington Revision Express: Economics Longman – Pearson

25. END