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Harcourt Brace & Company Chapter 6 Supply, Demand, and Government Policies
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Harcourt Brace & Company
Chapter 6
Supply, Demand, and
Government Policies
Harcourt Brace & Company
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!
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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.
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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.
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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.
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Market Impacts of a Price Ceiling
Supply
Demand
Price
Quantity
EquilibriumPrice
EquilibriumQuantity
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A Price Ceiling
Supply
Demand
Price
Quantity
PE
QE
PriceCeiling
PC
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A Price Ceiling Creates Shortages.
Supply
Demand
Price
Quantity
PE
QE
PC
QS QD
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A Price Ceiling Creates Shortages.
Supply
Demand
Price
Quantity
PE
QE
PC
QS QD
Shortage
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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)
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Price Floors
When the government imposes a price floor, a legal minimum price, causes a surplus if the price is set above equilibrium price.
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A Price Floor
Supply
Demand
Price
Quantity
PE
QE
PriceFloor
PF
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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.
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A Price Floor Creates a Surplus.
Supply
Demand
Price
Quantity
PE
QE
PF
QS QD
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A Price Floor Creates a Surplus.
Supply
Demand
Price
Quantity
PE
QE
PF
QS QD
Surplus
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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
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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.
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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?
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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.
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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?
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Tax on Sellers
Supply falls Quantity falls Price that the buyer pays rises The return to the seller falls
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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!
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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.
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Elasticity and Excise Tax Example:A more inelastic demand and more elastic supply.
Supply
Demand
$2.00
250
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Elasticity and Excise Tax
S1
Demand
S2
Specific Tax $.20
$2.00
$2.15
200 250
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Elasticity and Excise Tax
S1
Demand
S2
Specific Tax $.20
$2.15
$2.00$1.95
200 250
Seller’s burden of tax
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Elasticity and Excise Tax
S1
Demand
S2
Specific Tax $.20
$2.15
$2.00$1.95
200 250
Buyer’s burden of tax
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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
