Lecture Microeconomics - Chapter 4: Supply, Demand and Gov Policies

Lecture Microeconomics - Chapter 4: Supply, Demand and Gov Policies present the content supply policies, demand policies, Gov policies, control on prices, price ceiling, price floor, taxes,...

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HUTECH Institute of International Education Supply, Demand and Government policies

TOPIC 4

SUPPLY, DEMAND AND GOVERNMENT POLICIES

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HUTECH Institute of International Education

CONTROL ON PRICES

4.1

Control on Prices

policy-makers believe that the market price is unfair to buyers and sellers.

and price floors.

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Price Ceiling

A price ceiling is the maximum legal price a seller may

charge for a product or service shown in the graph below:

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Why impose a Price ceiling?

essential items such as petrol, rice etc

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Quantity demanded

Quantity supplied

125

Shortage

➔ No effects on the price or quantity sold ➔ The ration mechanism – not desirable

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• 1973, OPEC raised the price of crude oil

– Reduced the supply of gasoline

– Long lines at gas stations

• What was responsible for the long gas lines?

– OPEC: created shortage of gasoline

– U.S government regulations: price ceiling on gasoline

• Before OPEC raised the price of crude oil

– Equilibrium price - below price ceiling: no effect

• When the price of crude oil rose

– Reduced the supply of gasoline– Equilibrium price – above price ceiling: shortage

Lines at the gas pump

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HUTECH Institute of International Education Control on Prices

- When OPEC increases P → reduces

Q → S curve move to the left

- Without Ceiling Price??

- With Ceiling price? Why lines at gas pump?

Lines at the gas pump

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• Price ceiling: rent control

– Local government - ceiling on rents

– Goal: help the poor (housing more affordable) – But what’re the real effects?

Rent control in the short run

and the long run

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Rent control in short and long run

considered unchanged (because landlord cannot change these number

in short time) → S curve is vertical

✓Tenants may not be responsive to rents because of living habit, they

need time → D curve is relatively

slope

✓S and D curves for apartments are relatively inelastic

→ Small shortage

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11 HUTECH Institute of International Education

Rent control in short and long run

Rent

price

Ceiling price Shoratge

✓ Supply side: Landlords - not

building new apartments & failing to maintain existing ones; reduce

number of house rents

→ Supply is elastic → S curve is flat

✓ Demand side: - find their own

apartments & induce more people to move into a city

→ Demand is elastic → D curve is flat

→ Large shortage of housing LONG TERM

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• Adverse effects of rent control in the long run

– Rationing mechanisms

• Long waiting lists

• Preference to tenants without children

• …– Tenants get lower rents but also lower-quality house

Rent control in the short run

and the long run

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Price Floor

Price floors are minimum prices fixed by government that

are above equilibrium prices.

Pf is the minimum

legal price that a

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Why impose a price floor?

• To support prices (income) in important sectors of the economy (eg Agriculture)

• To protect workers (eg minimum wages)

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Quantity supplied

Quantity demanded

120

Surplus

➔ No effects on the price or quantity sold ➔ Binding price floor causes a surplus

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• Price floor: minimum wage

– Lowest price for labor that any employer may pay

• Fair Labor Standards Act of 1938

– Ensure workers a minimally adequate standard ofliving

• If minimum wage – above equilibrium

– Unemployment

– Higher income - workers who have jobs

– Lower income - workers who cannot find jobs

The minimum wage

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(b) A Labor Market with a Binding Minimum Wage

Labor surplus (unemployment)

Labor demand

Labor supply

Minimum wage

•If minimum wage is

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• Impact of the minimum wage

– Workers with high skills and much experience

• Not affected: Equilibrium wages - above the minimum

• Minimum wage - not binding

– Teenage labor – least skilled and least

experienced

• Low equilibrium wages

• Willing to accept a lower wage in exchange for the-job training

on-• Minimum wage – binding

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Evaluating Price controls

Control on Prices

good way to organize economic activity”

price floors

activity

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Evaluating Price controls

Control on Prices

sometimes improve market outcomes”

- Impose price controls: because of unfair market outcome

- Rent subsidies

- Wage subsidies

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TAXES

4.2

Control on Prices

amount for each unit sold.

Who actually bears the burden of tax

Buyers? Or Sellers?

Tax incidence: the manner in which the burden of

a tax is shared among participants in a market

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Taxes on sellers

Control on Prices

→ shifts the S curve

→ S curve shifts to the left

➔ Taxes reduce size of the market

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Taxes on sellers

Control on Prices

Price of Ice-Cream

Cone

Quantity of Ice-Cream Cones 0

sellers

receive

A tax on sellers shifts the supply curve upward

by the size of the tax ($0.50).

Tax ($0.50) Equilibrium without tax

Equilibrium with tax

→ Tax discourage the market activity

→ Buyers pay more and sellers receive less

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Taxes on buyers

Control on Prices

→ shifts the D curve

→ D curve shifts downward to the left

➔ Taxes reduce size of the market

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Taxes on buyers

Control on Prices

Price of Ice-Cream

Cone

Quantity of Ice-Cream Cones 0

by the size of the tax ($0.50).

Tax ($0.50)

Equilibrium without tax Equilibrium with tax

D2

 Taxes levied on sellers and taxes levied on buyers are equivalent

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Elasticity and Tax Incidence

CASE 1: Supply is more elastic than demand

P

Q D

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CASE 2: Demand is more elastic than supply

P

Q D

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CONCLUSION: How the burden of a tax is divided?

When the good is taxed, the side of the market with fewer good alternatives is less willing to leave the market and must, therefore, bear more of the burden

of the tax.

➔ A tax burden falls more heavily on the side of the market that is less elastic.

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▪ We have Demand and Supply curve as follow:

Convert to price function:

and price sellers receive

Tax = PD - PS

How to determine the price buyers

pay and price sellers receive?

Control on Prices

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Consider the market for good X,

Q d = 206 - 2P and Q s = -69 + 3P

with P (thousand VND/kg) and Q (thousand tons)

a) Calculate the equilibrium price and quantity? The total

revenue of the supplier?

b) Assume tax=20,000 VND/kg Determine the equilibrium

quantity and the price buyer pays and price sellerreceive?

c) How much taxes does the government collect? Who

bears the higher taxes; and how much?

Example

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a) Q d = Q s

Qd = Qs = 96 (thousand tons)

Total revenue = P*Q = 55*96 = 5280 (million VND)

b) Convert D function and S function as form of P = f(Q):

PD = - 1/2*Q+103 and PS = 1/3*Q +23

Tax = PD – PS = 20 → Q = 72 (thousand tons)

→ PS = 47 and PD = 67 (thousand VND/kg)

Solutions

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c) Government collects taxes:

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d) Assume Government wants to reduce the quantity ofgood X in the market to 60 thousand tons by imposing tax.How much taxes Government need to impose on good X?Total taxes that Government collects?

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