Transcript price ceiling

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
“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
fig
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
What are the results?
P
S
Pe
maximum
price
shortage
D
O
Qs
fig
Qd
Q
What are likely to happen?

Effects:


dealing with resulting shortages
=> rationing
black markets
P
Effect of price control on blackmarket prices
S
Blackmarketeers’
profits
Pb
Pe
Price ceiling
Pg
D
O
Qs
Qd
Q
fig
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



After Price ceiling



CS = A+B
PS = C+E+F
CS = A+C
PS = F
What about B & E?

net loss in total
surplus
Price Floors
A 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)
P
What is the impact?
S
surplus
minimum
price
Pe
D
O
Qd
fig
Qs
Q
Gainers & Losers?
Gainers
Losers:
 Suppliers who receive
 Consumers who have
higher price per unit
to pay higher prices for
and probably, higher
the goods.
income.
 Workers who are in job
 Workers who were
receive a higher wage
previously working, are
now unemployed
Price Controls, CS & PS

Originally



CS = A+B+C
PS = E+F
After Price floor



(contd.)
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:
S1
P
Tax
E1
Consumers’ tax burden >
Producers’ tax burden if
Demand is relatively
inelastic
Consumers’ tax burden
E0
Producers’ tax burden
So
D
Q1 Q0
Q
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