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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