7/27/2019 Ecn 201 Lecture 4
1/14
Lecture 4
Impact of govt. policies
7/27/2019 Ecn 201 Lecture 4
2/14
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,
it may be true that not everyone is satisfied.
Price control is an important policy of govt.
which can significantly affect the peoples
welfare.
7/27/2019 Ecn 201 Lecture 4
3/14
CONTROLS ON PRICES
Price control is usually enacted when
policymakers believe the market price is unfair
to buyers or sellers.
There are two types of price control:
1) Price ceilings
2) Price floors.
7/27/2019 Ecn 201 Lecture 4
4/14
Price Ceiling
Price Ceiling
A legal maximum on the price at which a good canbe sold.
Effects of Price CeilingsA price ceiling creates shortages of the productbecause QD > QS.
Example: Price ceiling of some of the essentialproducts during Ramadan. The result of priceceiling is rationing.
7/27/2019 Ecn 201 Lecture 4
5/14
A Market with a Price Ceiling
Quantity ofIce-Cream
Cones0
Price ofIce-Cream
Cone
Demand
Supply
2 PriceceilingShortage
75Quantitysupplied
125Quantity
demanded
Equilibriumprice
$3
7/27/2019 Ecn 201 Lecture 4
6/14
Why prices of essentials go on rising during
Ramadan and how govt. control price
Every year, wholesale and retail prices of essentials shoot up during theholy fasting month of Ramadan not only in Bangladesh but also in manyother Muslim countries. Traders do it, taking advantage of the anticipatedspike in local demand. Prices start to take vertical drift leaving thecommon and especially marginal people beyond their purchasing capacity.Initiatives are taken each and every year; however, we lose the battle in
containing soaring prices due to excessive profit motives of someAbusinessmen and lack of proper monitoring by the government ahead ofthe Ramadan.
Under these circumstances (like any other year) in 2013 govt. tookinitiative to control price. Govt. decided to set ceiling prices for some ofthe essential commodities. For example govt. fixed the retail price oflentils at Tk. 70-80 per kg, chickpeas at Tk. 62 per kg and dates at Tk. 75-80per kg.
7/27/2019 Ecn 201 Lecture 4
7/14
Price Floor
Price Floor
A legal minimum on the price at which a good can
be sold.
The price floor is a price which is set above the
equilibrium price, leading to a surplus of the
product as QS > QD.
Examples: The minimum wage, agricultural
price supports
7/27/2019 Ecn 201 Lecture 4
8/14
A Market with a Price Floor
Quantity ofIce-Cream
Cones0
Price ofIce-Cream
Cone
Demand
Supply
$4 Pricefloor
80Quantity
demanded120
Quantitysupplied
Equilibriumprice
Surplus
3
7/27/2019 Ecn 201 Lecture 4
9/14
Example of Price Floor: Minimum Wage Law
An important example of a price floor is the
minimum wage. Minimum wage laws dictate
the lowest price possible for labor that any
employer may pay.
7/27/2019 Ecn 201 Lecture 4
10/14
How the Minimum Wage Affects the Labor Market
Quantity of
Labor
Wage
0
LaborSupplyLabor surplus
(unemployment)
Labordemand
Minimumwage
Quantitydemanded Quantitysupplied
7/27/2019 Ecn 201 Lecture 4
11/14
TAXES
Governments levy taxes to raise revenue for
public projects.
What was the impact of tax?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden.
7/27/2019 Ecn 201 Lecture 4
12/14
Elasticity and Tax Incidence
Tax incidence is the manner in which the
burden of a tax is shared among participants
in a market.
Tax incidence is the study of who bears the
burden of a tax.
Taxes result in a change in market equilibrium.
Buyers pay more and sellers receive less,
regardless of whom the tax is levied on.
7/27/2019 Ecn 201 Lecture 4
13/14
A Tax on Buyers
Quantity ofIce-Cream Cones0
Price ofIce-Cream
Cone
Pricewithout
tax
Pricesellersreceive
Equilibrium without taxTax ($0.50)
Pricebuyers
pay
D1D2
Supply, S1
A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).
$3.30
90
Equilibriumwith tax
2.803.00
100
7/27/2019 Ecn 201 Lecture 4
14/14
A Tax on Sellers
2.80
Quantity ofIce-Cream Cones
0
Price ofIce-CreamCone
Pricewithout
tax
Pricesellersreceive
Equilibriumwith tax
Equilibrium without taxTax ($0.50)
Pricebuyers
payS1S2
Demand, D1
A tax on sellersshifts the supplycurve upwardby the amount ofthe tax ($0.50).
3.00
100
$3.30
90