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Economic Analysis Economic Analysis for Businessfor Business
Session VIII: Supply Demand Session VIII: Supply Demand and Government Policies-Iand Government Policies-IInstructorInstructorSandeep BasnyatSandeep [email protected][email protected]
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
Government Policies That Alter the Private Government Policies That Alter the Private Market OutcomeMarket Outcome
Price controls◦Price ceiling: a legal maximum on the
price of a good or service. Example: rent control.
◦Price floor (Price support): a legal minimum on the price of a good or service. Example: minimum wage.
Taxes and Subsidies◦The govt. can make buyers or sellers pay a
specific amount on each unit bought/sold.
Price Control Policy :Price Control Policy : Rent Control in the Rent Control in the Short Run and Long RunShort Run and Long Run
Rent controls are ceilings placed on the rents that landlords may charge their tenants.
The goal of rent control policy is to help the poor by making housing more affordable.
One economist called rent control “the best way to destroy a city, other than bombing.”
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
RENT CONTROL: The Market for RENT CONTROL: The Market for ApartmentsApartments
Eq’m w/o price
controls
Eq’m w/o price
controls
P
QD
SRental price of
apts
$800
300
Quantity of apartments
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
How Price Ceilings Affect Market How Price Ceilings Affect Market OutcomesOutcomes
A price ceiling above the eq’m price is
not binding – it has no effect on the market outcome.
P
QD
S
$800
300
Price ceiling
$1000
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
How Price Ceilings Affect Market How Price Ceilings Affect Market OutcomesOutcomesThe eq’m price ($800) is above the ceiling and therefore illegal.The ceiling is a binding constraint on the price, and causes a shortage.
P
QD
S
$800
Price ceiling
$500
250 400
shortage
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
How Price Ceilings Affect Market How Price Ceilings Affect Market OutcomesOutcomes
In the long run, supply and demand are more price-elastic. So, the shortage is larger.
P
QD
S
$800
150
Price ceiling
$500
450
shortage
In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline.
What was responsible for the long gas lines?
CASE STUDY:CASE STUDY: Lines at the Gas Lines at the Gas PumpPump
• Economists blame government regulations that limited the price oil companies could charge for gasoline.
The Market for Gasoline with a Price CeilingThe Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Quantity ofGasoline
0
Price ofGasoline
1. Initially,the priceceilingis notbinding . . . Price ceiling
Demand
Supply, S1
P1
Q1
The Market for Gasoline with a Price CeilingThe Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Quantity ofGasoline
0
Price ofGasoline
Demand
S1
S2
Price ceiling
QS
4. . . . resultingin ashortage.
3. . . . the priceceiling becomesbinding . . .
2. . . . but whensupply falls . . .
P2
QD
P1
Q1
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
PRICE FLOOR (PRICE SUPPORT) : PRICE FLOOR (PRICE SUPPORT) : The Market The Market for Unskilled Laborfor Unskilled Labor
Eq’m w/o price
controls
Eq’m w/o price
controls
W
LD
SWage paid to
unskilled workers
$4
500
Quantity of unskilled workers
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
How Price Floors Affect Market How Price Floors Affect Market Outcomes?Outcomes?
W
LD
S
$4
500
Price floor
$3
A price floor below the eq’m price is not binding – it has no effect on the market outcome.
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
How Price Floors Affect Market OutcomesHow Price Floors Affect Market Outcomes
W
LD
S
$4
Price floor
$5
The eq’m wage ($4) is below the floor and therefore illegal.The floor is a binding constraint on the wage, and causes a surplus (i.e., unemployment).
400 550
labor surplus
Case Study: The Minimum WageCase Study: The Minimum WageAn important example of a price
floor is the minimum wage. Minimum wage laws dictate the lowest price possible for labor that any employer may pay.
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
Min wage laws do not affect highly skilled workers.
They do affect teen workers.
Studies: A 10% increase in the min wage raises teen unemployment by 1-3%.
The Minimum WageThe Minimum Wage
W
LD
S
$4
Min. wage
$5
400 550
unemp-loyment
Impact of Minimum Wage Impact of Minimum Wage LawsLaws
•Skills and Experience: No effects or not binding because their equilibrium wage rates are well above minimum wage
•Teenage labour: Least skilled and least experienced. Minimum wage law hits them hard.
• Impact on quantity of labour supplied: Increases the quantity of labor supplied as more teenagers will be interested to work, a result of which they will drop out of schools.
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
Evaluating the Effects of Price Evaluating the Effects of Price ControlsControls
Prices are the signals that guide the allocation of society’s resources. This allocation is altered when policymakers restrict prices.
Price controls are often intended to help the poor, but they often hurt more than help them:
• The min. wage can cause job losses.
• Rent control can reduce the quantity and quality of affordable housing.
Numerical ProblemsNumerical ProblemsConsider a market with Demand curve q = 16 − 10p and Supply curve q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg)
(a)Determine the market equilibrium price and quantity and the total revenue in this market.
(b)Calculate the price elasticity of demand and the price elasticity of supply at the market equilibrium.
Solved ProblemsSolved ProblemsConsider a market with Demand curve q = 16 − 10p and Supply curve q = −8 + 20p. (Here q is in millions of kgs and p is in dollars per kg.)
(a) Determine the market equilibrium price and quantity and the total revenue in this market.Simultaneously solving the demand and supply equations:
p = $0.80 per kg. and q = 8 million kgs.
Total revenue is: p x q = 0.8 x 8 = $6.4 millions.
(b) Calculate the price elasticity of demand and the price elasticity of supply at the market equilibrium.
The slope of the demand curve is −10, so the price elasticity of demand at the market equilibrium is −10.(0.8/8) = −1.
Similarly, the slope of the supply curve is 20, so the price elasticity of supply at the market equilibrium is 20.(0.8/8)= 2.
Numerical ProblemsNumerical ProblemsConsider a market with Demand curve q = 16 − 10p and Supply curve q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg)
c)Suppose the government sets support price of $1 per kg in this market and purchases the surplus at support price. Find the quantity demanded, quantity supplied and government expenditure in this market to implement the policy.
d)Illustrate in diagram the results obtained in part (c).
Numerical ProblemsNumerical ProblemsConsider a market with Demand curve q = 16 − 10p and Supply curve q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg)
c)Suppose the government sets support price of $1 per kg in this market and purchases the surplus at support price. Find the quantity demanded, quantity supplied and government expenditure in this market to implement the policy.
At, support price of $1/kg,
Quantity demanded = 16 – 10(1) = 6 million kgs.
Quantity Supplied = - 8 + 20(1) = 12 million kgs.
There will be a surplus of 6 million kgs in the market.
Total Government expenditure = 6 x 1 = $6 million.
CHAPTER 6 SUPPLY, DEMAND, AND
GOVERNMENT POLICIES
(d) Illustration of part c on Price Support (d) Illustration of part c on Price Support PolicyPolicy
W
LD
S
$0.8
Price support (floor)
$1
6 12
Surplus = 6 million kgs.
8
Govt. Spending
Thank youThank you