Post on 04-Jan-2016
Government in the Market
Market Disequilibrium
• If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium will exist.
• In a competitive market, market forces will push the market back to equilibrium.
DisequilibriumPrice
QuantityD
S
A B Pa
Q1 Q2
When price exceeds theequilibrium price, quantitysupplied is greater thanquantity demanded and asurplus is created.
0
DisequilibriumPrice
QuantityD
S
C F
Pb
Q1 Q2
When price is less than theequilibrium price, a shortageis created.
0
DisequilibriumPrice
QuantityD
S
A B
C F
Pa
Pb
Q1 Q2
If price is above equilibrium,market forces will push itdown to equilibrium.
If price is below equilibrium,market forces will push itup to equilibrium.
0
Disequilibrium to Equilibrium
• If price equals Pa, quantity supplied exceeds quantity demanded by the amount AB.– The amount AB is excess inventory that
businesses will sell at a lower price.• As price falls, quantity demanded increases
• As price falls, quantity supplied decreases.
– When quantity demanded equals quantity supplied, equilibrium is reached.
Disequilibrium to Equilibrium
• If price equals Pb, quantity supplied is less than quantity demanded by the amount CF.– The amount CF represents excess demand for the
product, permitting businesses to raise price to take advantage of the good’s popularity.
• As price rises, quantity demanded decreases
• As price rises, quantity supplied increases.
– When quantity demanded equals quantity supplied, equilibrium is reached.
Government Policies and the Market
• Permanent shortages and surpluses can be created through government policies.– A price ceiling is an attempt to keep prices
from rising.– A price floor is an attempt to keep prices from
falling.
DisequilibriumPrice
QuantityD
S
A B
C F
Pa
Pb
Q1 Q2
Pa is an example of a price ?
0
Price Floors
• A price floor is an attempt to keep price from falling to equilibrium. Therefore, it must be set above equilibrium.
• Price floors cause surpluses because they send a false market signal.– The artificially high price simultaneously
increases quantity supplied and decreases quantity demanded.
DisequilibriumPrice
QuantityD
S
A B
C F
Pa
Pb
Q1 Q2
Pb is an example of a price ?
0
Price Ceiling
• A price ceiling is an attempt to keep price from rising to equilibrium. Therefore, it must be set below equilibrium.
• Price ceilings cause shortages because they send a false market signal.– The artificially low price simultaneously
decreases quantity supplied and increases quantity demanded.
Taxes
• Taxes are levied by all levels of government and are a cost of business.
• Therefore, we show the effect of a change in taxes by shifting the supply curve– Increases in taxes shift the supply curve to the
left.– Decreases in taxes shift the supply curve to the
right.
Tax Increase
0 Q
D
S1
S2
P
Q1 Q2
P2
P1a
b
At point a, the equilibrium output/price combination is Q2/P1.
The imposition of a tax shifts thesupply curve from S1 to S2.
At the new equilibrium, theoutput/price combinationis Q1/P2.
Output falls while price rises.
Tax Increase
0 Q
D
S1
S2
P
Q1 Q2
P3
P2
P1
a
b
c
The tax equals the distance bc or P1P3.
Tax revenue received equals the areaP1P3bc.
Note that the change in the equilibrium price associated with the imposition of the tax, P2P3, is less than the tax.
Why?
Tax Incidence
• Taxes are not necessarily borne where they are placed. They can be shifted.
• The ability to shift a tax depends on the elasticities of demand and supply.
• Taxes are borne where the inelasticity is the greatest.
Tax Incidence
0 Q
D
S1
S2
P
Q1 Q2
P3
P2
P1
a
b
c
In this case, the consumer and thefirm bear approximately equal amounts of the tax.
Price rises to the consumer by theamount P2P3. The consumer bearsP2P3be.
Price received by the supplier fallsby the amount P2P1. The firm bearsP2P1ce.
e
Tax Increase and Demand Elasticity
0 Q
D
S1
S2P
Q1 Q2
P3
P2
P1
ab
Elastic Demand
c
f
When demand is more elastic than supply, the consumer bears a smaller part of the tax.
His/her share of the tax is the amount cb while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His burden is the amount P1P2cf.
Tax Increase and Demand Elasticity
0 Q
S1
S2
P
Q2Q3
P2
P1
a
b
D
P3
When demand is less elastic than supply, the consumer bears a larger
part of the tax.
The consumer’s share of the tax is the amount cb while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His burden is the amount P1P2cf.
c
f
c
Inelastic Demand
Tax Increase and Supply Elasticity
0 Q
D
S1
S2
P
Q1 Q2
P3
P2
P1
a
b
c
f
Elastic Supply
When supply is more elastic than demand, the consumer bears a larger part of the tax.
His/her share of the tax is the amount cb while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His burden is the amount P1P2cf.
Tax Increase and Supply Elasticity
0 Q
D
S1S2P
Q1 Q2
P3
P2a
b
P1
c
f
Inelastic Supply
When supply is less elastic than demand,the consumer bears a smaller part of the tax.
His/her share of the taxis the amount cb while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His total burden is the amount P1P2cf.
Conclusions
• Taxes are borne where the inelasticity is the greatest.
• The amount produced decreases more when demand is more elastic. As a result, total tax revenues decline more when demand is more elastic.– Governments prefer to tax inelastic products
such as cigarettes, liquor, gasoline.
Conclusions
• Businesses don’t pay taxes; people do.– Taxes may be shifted forward to the consumer or
backward to workers.
• Taxes imposed on goods and services where the elasticity of demand is inelastic result in smaller changes in production and, therefore, are more efficient.
• There are, however, equity issues.• What are they?
Tax Increases and Demand Elasticity
0 Q
D
S1
S2P
Q1 Q2Q3
P1
P2a
b
D
P3 When demand in less elastic, theimposition of a tax results in agreater change in price and asmaller change in quantity demanded.
c