Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Chapter 6...

Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition

Chapter 6

Supply, Demand, and

Government Policies

© 2002 by Nelson, a division of Thomson Canada Limited


Overview

The Effects of Price ControlsThe Effects of an Excise Tax


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, i.e. buyer or seller are satisfied.

Hence, market controls!


Market Price Controls

Are usually enacted when policy-makers believe that the market price is unfair to buyers and sellers.

Result in government policies, i.e. price ceilings and floors.


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.


Price Ceilings

When the government imposes a price ceiling (i.e... a legal maximum on the price at which a good can be sold) two outcomes are possible:1 . The price ceiling is not binding.

2 . The price ceiling is a binding constraint on the market, creating Shortages.


Market Impacts of a Price Ceiling

Supply

Demand

Price

Quantity

EquilibriumPrice

EquilibriumQuantity


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


A Binding Price Ceiling Creates Shortages.

Supply

Demand

Price

Quantity

PE

QE

PC

QS QD

Shortage


Market Impacts of a Price CeilingA 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


Price Floors

When the government imposes a price floor (i.e... a legal minimum on the price at which a good can be sold) two outcomes are possible:1 . The price floor is not binding.

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 market 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.


A Binding Price Floor Creates a Surplus.

Supply

Demand

Price

Quantity

PE

QE

PF

QS QD


Supply

Demand

Price

Quantity

PE

QE

PF

QS QD

Surplus

A Binding Price Floor Creates a Surplus.


Market Impacts of a Price Floor

A Binding Price Floor creates. . .– Surpluses (i.e. Quantity Supplied >

Quantity Demanded)

– Non-Price Rationing - An alternative mechanism for rationing of the good:Discrimination Criteria

– Examples:Minimum Wage Agricultural Price Supports


Quick Quiz!

Define “price ceiling” and “price floor”

Give an example of each.

Which leads to a shortage, which a surplus? Why?


Overview



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’s independent of the price of the product.


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. Buyers and sellers

share the tax burden.


Taxes: Impact From a 50 Cent Tax

S1

$3.00

800

D1

Equilibrium without tax

Quantity

Price



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



S1

$3.00

800

$3.30

600

The tax increasesthe market price

to the buyer...

$2.80

D1

Quantity

Price



S1

$3.00

800

$3.30

600

The tax increasesthe market price

to the buyer...…in this case theprice rises $.30.

$2.80

D1Price

Quantity



S1

$3.00

800

$3.30

600

The tax decreasesthe return to the

seller as the sellergets $.20 less.

$2.80

D1

Quantity

Price



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.


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!


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:A more inelastic demand and more elastic supply.

Supply

Demand

$2.00

250

Price

Quantity


Elasticity and Excise Tax

S1

Demand

S2

Specific Tax $.20

$2.00

$2.15

200 250

Price

Quantity



S1

Demand

S2

Specific Tax $.20

$2.15

$2.00$1.95

200 250

Producer’s burden of tax

Price

Quantity



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.


Supply, Demand & GovernmentThe 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


Overview


Principles of Microeconomics & Principles of Macroeconomics: Ch.6 Second Canadian Edition Chapter 6...

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