Transcript Market Disequilibrium

Government in the Market
Market Disequilibrium
• If quantity demand exceeds quantity
supplied or quantity supplied exceeds
quantity demanded, a disequilibrium will
exist.
• In a competitive market, market forces will
push the market back to equilibrium.
Disequilibrium
Price
S
Pa
B
A
When price exceeds the
equilibrium price, quantity
supplied is greater than
quantity demanded and a
surplus is created.
D
0
Q1
Q2
Quantity
Disequilibrium
Price
S
When price is less than the
equilibrium price, a shortage
is created.
Pb
C
F
D
0
Q1
Q2
Quantity
Disequilibrium
Price
S
Pa
Pb
A
If price is above equilibrium,
market forces will push it
down to equilibrium.
B
C
F
D
0
Q1
Q2
If price is below equilibrium,
market forces will push it
up to equilibrium.
Quantity
Disequilibrium to Equilibrium
• If price equals Pa, quantity supplied exceeds
quantity demanded by the amount AB.
– The amount AB is excess inventory that
businesses will sell at a lower price.
• As price falls, quantity demanded increases
• As price falls, quantity supplied decreases.
– When quantity demanded equals quantity
supplied, equilibrium is reached.
Disequilibrium to Equilibrium
• If price equals Pb, quantity supplied is less
than quantity demanded by the amount CF.
– The amount CF represents excess demand for
the product, permitting businesses to raise price
to take advantage of the good’s popularity.
• As price rises, quantity demanded decreases
• As price rises, quantity supplied increases.
– When quantity demanded equals quantity
supplied, equilibrium is reached.
Government Policies and the
Market
• Permanent shortages and surpluses can be
created through government policies.
– A price ceiling is an attempt to keep prices
from rising.
– A price floor is an attempt to keep prices from
falling.
Disequilibrium
Price
S
Pa
Pb
A
B
C
Pa is an example of a
price
?
F
D
0
Q1
Q2
Quantity
Price Floors
• A price floor is an attempt to keep price
from falling to equilibrium. Therefore, it
must be set above equilibrium.
• Price floors cause surpluses because they
send a false market signal.
– The artificially high price simultaneously
increases quantity supplied and decreases
quantity demanded.
Disequilibrium
Price
S
Pa
Pb
A
B
C
Pb is an example of a
price
?
F
D
0
Q1
Q2
Quantity
Price Ceiling
• A price ceiling is an attempt to keep price
from rising to equilibrium. Therefore, it
must be set below equilibrium.
• Price ceilings cause shortages because they
send a false market signal.
– The artificially low price simultaneously
decreases quantity supplied and increases
quantity demanded.
Taxes
• Taxes are levied by all levels of government
and are a cost of business.
• Therefore, we show the effect of a change
in taxes by shifting the supply curve
– Increases in taxes shift the supply curve to the
left.
– Decreases in taxes shift the supply curve to the
right.
Tax Increase
S2
P
P2
P1
S1
At point a, the equilibrium output/
price combination is Q2/P1.
The imposition of a tax shifts the
supply curve from S1 to S2.
b
a
At the new equilibrium, the
output/price combination
is Q1/P2.
D
Output falls while price rises.
0
Q 1 Q2
Q
Tax Increase
S2
P
P3
P2
P1
The tax equals the distance bc or
S1 P P .
1 3
Tax revenue received equals the area
P1P3bc.
b
a
Note that the change in the equilibrium
price associated with the imposition of
the tax, P2P3, is less than the tax.
c
D
0
Q 1 Q2
Why?
Q
Tax Incidence
• Taxes are not necessarily borne where they
are placed. They can be shifted.
• The ability to shift a tax depends on the
elasticities of demand and supply.
• Taxes are borne where the inelasticity is the
greatest.
Tax Incidence
S2
P
P3
P2
P1
In this case, the consumer and the
firm bear approximately equal
amounts of the tax.
S1
b
e
Price rises to the consumer by the
amount P2P3. The consumer bears
P2P3be.
a
c
Price received by the supplier falls
by the amount P2P1. The firm bears
P2P1ce.
D
0
Q 1 Q2
Q
Tax Increase and Demand Elasticity
S2
P
S1
When demand is more elastic than
supply, the consumer bears a smaller
part of the tax.
P3
P2
P1
b
c
a
His/her share of the tax is the
amount cb while his/her total burden
is the area P2P3bc.
f
D
The supplier’s share is the amount
cf. His burden is the amount P1P2cf.
0
Q1 Q 2
Elastic Demand
Q
Tax Increase and Demand Elasticity
S
P
2
S1
b
P3
P2
P1
When demand is less elastic than
supply, the consumer bears a larger
part of the tax.
cc
The consumer’s share of the tax is the
amount cb while his/her total burden
is the area P2P3bc.
a
f
The supplier’s share is the amount cf.
His burden is the amount P1P2cf.
D
0
Q2Q3
Inelastic Demand
Q
Tax Increase and Supply Elasticity
P
S2
S1
P3
P2
P1
b
c
a
His/her share of the tax is the
amount cb while his/her total
burden is the area P2P3bc.
f
The supplier’s share is the amount
cf. His burden is the amount P1P2cf.
D
0
Q 1 Q2
Elastic Supply
When supply is more elastic than
demand, the consumer bears a
larger part of the tax.
Q
Tax Increase and Supply Elasticity
S2
P
S1
When supply is less elastic than demand,
the consumer bears a smaller part of the tax.
P3
P2
P1
b
c
His/her share of the taxis the amount cb
while his/her total burden is the area P2P3bc.
a
The supplier’s share is the amount cf. His
total burden is the amount P1P2cf.
f
D
0
Q 1 Q2
Inelastic Supply
Q
Conclusions
• Taxes are borne where the inelasticity is the
greatest.
• The amount produced decreases more when
demand is more elastic. As a result, total
tax revenues decline more when demand is
more elastic.
– Governments prefer to tax inelastic products
such as cigarettes, liquor, gasoline.
Conclusions
• Businesses don’t pay taxes; people do.
– Taxes may be shifted forward to the consumer or
backward to workers.
• Taxes imposed on goods and services where the
elasticity of demand is inelastic result in smaller
changes in production and, therefore, are more
efficient.
• There are, however, equity issues.
• What are they?
Tax Increases and Demand Elasticity
S2
P
P3
P1
P2
S1
c
When demand in less elastic, the
imposition of a tax results in a
greater change in price and a
smaller change in quantity demanded.
b
a
D
D
0
Q1 Q2Q3
Q