Harcourt Brace & Company Chapter 6 Supply, Demand, and Government Policies.

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Harcourt Brace & Company

Chapter 6

Supply, Demand, and

Government Policies

Supply, Demand and Government Policies

In a “free”, unregulated market system, market forces establish equilibrium

prices and exchange quantities.

While equilibrium conditions may be efficient, every buyer or seller may not

be satisfied.

Hence, market controls!

Market Price Controls

Are usually enacted when policymakers believe that the market price is unfair to buyers and sellers.

Result in governmental policies, i.e., price ceilings and floors.

Price Ceilings & Price Floors

A Price Ceiling – is a legally established maximum price

which a seller can charge or a buyer must pay.

A Price Floor– is a legally established minimum price

which a seller can charge or a buyer must pay.

Price Ceilings

When the government imposes a price ceiling, a legal maximum on the price, a shortage results, if the price is set below equilibrium price.

Market Impacts of a Price Ceiling

Supply

Demand

Quantity

EquilibriumPrice

EquilibriumQuantity

A Price Ceiling

Supply

Demand

Quantity

PriceCeiling

A Price Ceiling Creates Shortages.

Supply

Demand

Quantity

A Price Ceiling Creates Shortages.

Supply

Demand

Quantity

Shortage

Market Impacts of a Price Ceiling

A Price Ceiling creates. . .– Shortages (Qty Demanded > Qty

Supplied) Gasoline shortages of the 1970s

– Non-Price Rationing - An alternative mechanism for rationing of the good: Long Lines (First-In-Line, Figure 6-2)

Price Floors

When the government imposes a price floor, a legal minimum price, causes a surplus if the price is set above equilibrium price.

A Price Floor

Supply

Demand

Quantity

PriceFloor

Market Impacts of a Price Floor

A government imposed price floor hinders the forces of supply and demand in moving toward the equilibrium price and quantity.

When the market price hits the floor, it can fall no further and the market price equals the floor price. A price floor causes a surplus.

A Price Floor Creates a Surplus.

Supply

Demand

Quantity

A Price Floor Creates a Surplus.

Supply

Demand

Quantity

Surplus

Market Impacts of a Price Floor

A Price Floor creates. . .– Surpluses (Qty Supplied > Qty

Demanded)

– Non-Price Rationing - An alternative mechanism for rationing of the good: Discrimination Criteria

– Examples: Minimum Wage Agricultural Price Supports

Taxes! Taxes! Taxes! What is the purpose of government

imposed taxes?– To raise government revenues.

– To restrict allocation of a product. What is an excise tax?

– A “per-unit” tax that’s independent of the price of the product.

Taxes! Taxes! Taxes!

Who pays the tax on a good? The buyer or the seller?

How is the burden of a tax divided between buyer and seller?

Taxes: Impact

Taxes discourage market activity. The quantity of the good sold is smaller than

without the tax. Buyers and sellers

share the tax burden.

The Incidence of Tax. . .How is the burden of the tax distributed?

Consider a tax levied on sellers of a good.

How do effects of the tax levied on the seller compare with those of the effects imposed on the buyer?

Tax on Sellers

Supply falls Quantity falls Price that the buyer pays rises The return to the seller falls

The Incidence of Tax. . .How is the burden of the tax distributed?

The burden of a tax falls on the side of the market with the smaller price elasticity!

Elasticity and Taxes

The more INELASTIC the demand and the more ELASTIC the supply results in the consumer paying more of the tax.

The more ELASTIC the demand and the more INELASTIC the supply results in the supplier paying more of the tax.

Elasticity and Excise Tax Example:A more inelastic demand and more elastic supply.

Supply

Demand

Elasticity and Excise Tax

Demand

Specific Tax $.20

200 250

Demand

Specific Tax $.20

$2.00$1.95

200 250

Seller’s burden of tax

Demand

Specific Tax $.20

$2.00$1.95

200 250

Buyer’s burden of tax

Supply, Demand & Government The economy is governed by two kinds

of laws:– The laws of supply and demand– The laws enacted by government.

Price controls and taxes are common in various markets in the economy:– Price Ceilings– Price Floors– Excise Tax

Harcourt Brace & Company Chapter 6 Supply, Demand, and Government Policies.

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