Applications of Demand and Supply

1
Applications of Demand and Supply

• Topic 3

2
So far

• Demand Supply
• Equilibrium determined
• by market forces
• Equilibrium maintained
• by market forces

3
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

4
A price ceiling is the maximum legal price a
seller may charge for a good or service (Jackson
page 160)
S
P
Pe
Maximum price
D
O
Q
5
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?

6
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

7
What are the results?
P
S
Pe
maximum price
shortage
D
Qd
Qs
Q
O
8
What are likely to happen?

• Effects
• dealing with resulting shortages
• gt rationing
• black markets

9
Effect of price control on black-market prices
P
S
Blackmarketeers profits
Pb
Pe
Price ceiling
Pg
D
O
Qd
Qs
Q
10
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 )

11
Price Controls- Consumer Surplus Producer
Surplus

• Originally
• CS AB
• PS CEF
• After Price ceiling
• CS AC
• PS F
• What about B E?
• net loss in total surplus

12
Price FloorsA price floor is the minimum price
set by the govt 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?

13
Why does the government do it?

• To support prices (income) in important sectors
  of the economy (eg. Agriculture).
• To protect workers (eg. minimum wages)

14
What is the impact?
P
S
surplus
minimum price
Pe
D
Qd
Qs
Q
O
15
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

16
Price Controls, CS PS (contd.)

• Originally
• CS ABC
• PS EF
• After Price floor
• CS A
• PS CF
• What about B E?
• net loss in total surplus

17
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

18
Taxes on Producers

• Effects of imposing tax on producers

S1
P
Tax
So
E1
Consumers tax burden
Consumers tax burden gt Producers tax burden if
Demand is relatively inelastic
E0
Producers tax burden
D
Q
Q0
Q1
19
Taxes on Producers
20
Taxes on Producers
21
Taxes on producers
22
Taxes on Producers
23
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

24
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