Applications of Demand and Supply

Topic 3

So far…

Demand & Supply

Equilibrium determined by market forces

Equilibrium maintained by market forces

Price Controls Some cases market forces are not allowed

to determine equilibrium price and quantity

Intervention by authorities (Govt.) Price Ceilings Price Floors Taxes

on Producers on Consumers

fig

P

Q O

Pe

S

D

Maximumprice

“A price ceiling is the maximum legal price a seller may charge for a good or service” (Jackson page 160)

Price Ceilings Govt. sets the price LOWER than the

equilibrium.

Why would they do this? What is the result? Who benefits? Who loses? What is likely to happen?

Why would they do it?

To keep the price down to an acceptable level.

During wartime price controls may be imposed on essential items such as petrol, rice etc.

To help the poor & the disadvantaged

fig

P

Q O

Pe

QdQs

S

D

shortage

maximumprice

What are the results?

What are likely to happen?

Effects: dealing with resulting shortages => rationing black markets

fig

P

QO

Pb

Pg

Pe

Qs Qd

D

S

Effect of price control on black-market prices

Price ceiling

Blackmarketeers’

profits

Gainers & Losers?

Gainers Consumers who are

able to obtain supplies at the price ceiling

Losers: Consumers who

cannot obtain supplies

(even though they are willing to purchase at the equilibrium price )

Price Controls- Consumer Surplus & Producer Surplus

Originally CS = A+B PS = C+E+F

After Price ceiling CS = A+C PS = F

What about B & E? net loss in total

surplus

Price FloorsA price floor is the minimum price set by the gov’t for a good or service

Govt. sets the price floor HIGHER than the equilibrium

Why would they do this?

What is the result? Who benefits? Who

loses? What is likely to

happen?

Why does the government do it?

To support prices (income) in important sectors of the economy (eg. Agriculture).

To protect workers (eg. minimum wages)

fig

P

Q O

Pe

minimumprice

Qd Qs

S

D

surplus

What is the impact?

Gainers & Losers?

Gainers Suppliers who

receive higher price per unit and probably, higher income.

Workers who are in job receive a higher wage

Losers: Consumers who

have to pay higher prices for the goods.

Workers who were previously working, are now unemployed

Price Controls, CS & PS (contd.)

Originally CS = A+B+C PS = E+F

After Price floor CS = A PS = C+F

What about B & E? net loss in total

surplus

Taxes on Producers Supply curve shifts up

vertical shift = amount of tax

Equilibrium price increases, equilibrium quantity decreases

Notice the difference in amount of tax and increase in price.

As elasticity of demand and supply vary, the burden changes

Taxes on Producers

Effects of imposing tax on producers:

So

S1

Q

P

E0

E1

Q0Q1

Consumers’ tax burden

Tax

D

Consumers’ tax burden > Producers’ tax burden if Demand is relatively inelastic

Producers’ tax burden

Taxes on Producers

Taxes on Producers

Taxes on producers

Taxes on Producers

Taxes on Consumers Demand curve shifts

down vertical shift = amount of

tax Equilibrium price

decreases, equilibrium quantity decreases

Notice the difference in amount of tax and decrease in price.

As elasticity of demand and supply vary, the burden changes

Elasticity and Tax burden - Summary

Elastic Inelastic

Demand

Producer Consumer

Supply Consumer Producer

So, the burden of tax is not affected by who it is levied on (producer or consumer).

It is affected by the elasticities of demand & supply