35
Chapter 6 Supply, Demand, and Government Policies Ratna K. Shrestha
| Date post: | 05-Jan-2016 |
| Category: |
Documents |
| Upload: | ernest-gallagher |
| View: | 225 times |
| Download: | 4 times |
Chapter 6
Supply, Demand, and
Government Policies
Ratna K. Shrestha
Supply, Demand and Govt. Policies
In a “free”, unregulated market system, market forces establish equilibrium prices and quantities.
While equilibrium conditions may be efficient, not everyone, i.e. buyer or seller, is satisfied.
Hence, government may control the market to help either buyer or seller (often at the expense of other).
Examples: (1) Price control and (2) Excise tax, among others.
(1) Market Price Controls
Are usually enacted when policy-makers believe that the market price is unfair either to buyers or sellers.
Result in government policies, i.e. price ceilings and Price floors.
Price Ceilings & Price Floors
A Price Ceiling is a legally established maximum price
which a seller can charge (or a buyer must pay).
Examples: rent ceiling, ceiling on the price of gasoline in the US in 1970s.
A Price Floor is a legally established minimum price which
a buyer must pay. Examples: minimum wage.
Price Ceilings
When the government imposes a price ceiling two outcomes are possible:
1. The price ceiling is not binding. In this case the ceiling has no effect on the market outcomes.
2. The price ceiling is a binding constraint on the market, creating shortages.
A Non-Binding Price Ceiling
Supply
Demand
Price
Quantity
PE
QE
PriceCeiling
PC
A Binding Price Ceiling
Supply
Demand
Price
Quantity
PE
QE
PriceCeiling
PC
A Binding Price Ceiling Creates Shortages.
Supply
Demand
Price
Quantity
PE
QE
PC
QS QD
Shortage
Market Impacts of a Price Ceiling
A Binding Price Ceiling creates Shortages (i.e... Demand > Supply)
Gasoline shortages of the 1970sHousing shortages with rent controls
Non-Price Rationing - An alternative mechanism for rationing of the good:Long Lines (first-In-line, friends etc.)Discrimination criteria set by sellerBlack markets
Case Study: Lines At The Gas Pumps in the US in 1973
S2 (after P of crude oil increase)
Demand
Price
Quantity
P2
P1
PC
QS QD
Shortage
Q1
S1
Case Study: Rent ControlShort-Run Effect
Supply
Demand
Price
Quantity of Apts
PC
Shortage
With relatively inelastic Sand D, Shortage is smaller.
Case Study: Rent ControlLong-Run Effect
Supply
Demand
Price
Quantity of Apartments
PC
Shortage
In the long run, both Sand D become more elastic and the effect of rent control can be much bigger!
Price Floors
When the government imposes a price floor, two outcomes are possible:
1. The price floor is not binding. It does not affect the market outcomes. This is the case when the floor is lower than the equilibrium price. For example, if the govt. sets minimum wage at $6 (when the equilibrium wage is $8), it has no effect at all.
2. The price floor is a binding constraint on the market, creating surpluses.
A Non-Binding Price Floor
Supply
Demand
Price
Quantity
PE
QE
PriceFloor
PF
A Binding Price Floor
Supply
Demand
Price
Quantity
PE
QE
PriceFloor
PF
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 binding price floor causes a surplus. Examples:
Minimum Wage Agricultural Price Supports
Supply
Demand
Wage
Quantity of Labor
W*
QE
Wmin
QSQD
Surplus OrUnemployment
A Binding Price Floor Creates a Surplus.
Evaluating Price Controls
Policy makers control prices because they think the free-market prices are unfair. They are often aimed at helping the poor. Rent control laws try to make housing
affordable for the poor. Minimum wage laws are aimed at helping
the unskilled workers.
Evaluating Price Controls
But the irony is price controls often hurt those they are intended to help. Rent control discourages landlords from
maintaining their buildings and make housing hard to find.
Minimum wage laws cause unemployment and make it difficult for the unskilled workers to find jobs. While those who can maintain their jobs get higher pay, others can lose the jobs they had before.
• A law that raises the minimum wage above the market equilibrium wage creates unemployment.
• But how much unemployment does it create?
• Until recently, most economists believed that a 10% increase in the minimum wage rate decreased teenage employment by between 1 and 3 %.
Effect of Minimum Wage in Canada
Taxes! Taxes! Taxes!
What is the purpose of government- imposed taxes? To raise government revenues. To restrict production of a product.
What is an excise tax? A “per-unit” tax that is independent of the
price of the product. Example: tax on gasoline. The tax on gasoline is based on quantity. No matter what is the price of a liter of gasoline, the tax/liter is always the same.
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?
When the government levies a tax on a good, the equilibrium quantity of the good falls. The size of the market for that good shrinks, shifting either the demand or supply curve.
Taxes: Impact
Taxes discourage market activity. The quantity of the
good sold is smaller than without the tax.
Both buyers and sellers share the tax burden.
The question is who bears how much burden?
Taxes: Impact From a 50 Cent Tax
S1
$3.00
800
D1
Equilibrium without tax
Quantity
Price
Taxes: Impact From a 50 Cent Tax
S1
$3.00
800
D1
From the sellers viewpoint, the tax
causes the demand curve to
shift down by 50 cents.
$2.80
600
Price
Quantity
Taxes: Impact From a 50 Cent Tax
S1
$3.00
800
$3.30
600
The tax increases the market price to the buyer…in this case the price rises by $0.30 to $3.30.
$2.80
D1Price
Quantity
Taxes: Impact From a 50 Cent Tax
S1
$3.00
800
$3.30
600
The tax decreasesthe return to the
seller as the sellergets $0.20 less.
$2.80
D1
Quantity
Price
Taxes: Impact From a 50 Cent Tax
S1
$3.00
800
$3.30
600
The tax makes boththe buyer and the seller worse off!
$2.80
D1
Quantity
Price
The Incidence of Tax
How is the burden of the tax distributed? Consider a tax levied on sellers of a good.
What are the effects of this tax? How do effects of the tax levied on the seller
compare with those of the effects imposed on the buyer?
Depends on Elasticity of Demand and Elasticity of Supply, not on which side of the market it is imposed.
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
Supply
Demand
$2.00
250
Price
Quantity
A more inelastic demand and more elastic supply.
Elasticity and Excise Tax
S1
Demand
S2
Specific Tax $.20
$2.00
$2.15
200 250
Price
Quantity
Elasticity and Excise Tax
S1
Demand
S2
Specific Tax $.20
$2.15
$2.00$1.95
200 250
Producer’s burden of tax
Price
Quantity
Elasticity and Excise Tax
S1
Demand
S2
Specific Tax $.20
$2.15
$2.00$1.95
200 250
Buyer’s burden of tax
Price
Quantity
Quick Quiz
Show how a tax on car buyers of $1,000 per car affects the quantity of cars sold and the price of cars.
Show how a similar tax on car sellers affects quantity and price.
Hint: The incidence of tax is independent of which side of the market the tax is imposed!
How will a $1 tax on land sales be distributed between the landlord and the land buyer?
![sf7df8f}+ pkTosfsf] esDkLo kl/b[Zo - National Society for ... · PDF fileSagarmatha Insurance Co. Sugat Ratna Kansakar Manager Nepal Telecommunication Corp. Surya Bhakta Shrestha Deputy](https://static.documents.pub/doc/80x56/5aa1f2b97f8b9a84398c6021/sf7df8f-pktosfsf-esdklo-klbzo-national-society-for-insurance-co-sugat.jpg)
