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

TOPIC 4
SUPPLY, DEMAND
AND GOVERNMENT POLICIES

4.1

4.2

CONTROL
ON PRICES

TAXES

HUTECH Institute of International Education

Supply, Demand and Government policies


4.1 CONTROL ON PRICES
▪ The interests between buyers and sellers conflict

▪ The control on prices enacted when policymakers believe that the market price is unfair to
buyers and sellers.
▪ Result in government policies, i.e. price ceilings
and price floors.

HUTECH Institute of International Education

Control on Prices

CONTROL ON PRICES
▪ Price controls
➢ Price ceiling: a legal maximum on the price

of a good or service
➢ Price floor: a legal minimum on the price of
a good or service

Effects on the market outcome?

HUTECH Institute of International Education

Control on Prices


Price Ceiling
A price ceiling is the maximum legal price a seller may
charge for a product or service shown in the graph below:
P

S

Pe
Price Ceiling
Pc

PC is the
maximum legal
price that a firm
can charge!

D
QS

Qe

QD

Q

Excess Demand
HUTECH Institute of International Education

4


Why impose a Price ceiling?
• 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

HUTECH Institute of International Education


A market with a price ceiling
(a) A price ceiling that is not binding
Price

(b) A price ceiling that is binding
Price

Supply

Supply
Price ceiling

$4

Equilibrium
price

3

$3
Equilibrium
price

Price ceiling

2
Demand

Shortage
Equilibrium
quantity
0

100

Quantity of Ice-Cream Cones

➔ No effects on the price or quantity sold

HUTECH Institute of International Education

Quantity
supplied
0

Demand
Quantity
demanded

125
75
Quantity of Ice-Cream Cones

➔ The ration mechanism – not desirable

Control on Prices


Lines at the gas pump
• 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
P

S1

P

S2

S1

P2
PC

PC
P1

E

Ceiling price

P1

Ceiling price

D
Q1

Lượng

When OPEC remains Q,

Q2 QC Q1

Lượng

P1 < Ceiling price

- When OPEC increases P → reduces
Q → S curve move to the left

→ No effect on P or Q

- Without Ceiling Price??
- With Ceiling price? Why lines at gas
pump?

HUTECH Institute of International Education

Control on Prices

Rent control in the short run
and the long run
• 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 short and long run
In short run:
Rent
price

D

S

✓ Number of rent houses are
considered
unchanged
(because
landlord cannot change these number
in short time) → S curve is vertical

Ceiling price

PC
Shortage

Q

No of houses rent

SHORT TERM

HUTECH Institute of International Education

✓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
10


Rent control in short and long run
In long run:
Rent
price

D

✓ Supply side: Landlords - not
building new apartments & failing to
maintain existing ones; reduce
number of house rents

S

→ Supply is elastic → S curve is flat
Ceiling price
PC

Shoratge
Q

No of houses rent

LONG TERM

HUTECH Institute of International Education

✓ 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

11


Rent control in the short run
and the long run
• 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


Price Floor
Price floors are minimum prices fixed by government that
are above equilibrium prices.
P
S

Price Floors
Pf
Pe

Pf is the minimum
legal price that a
firm can charge

D
Qf

Qe

QD

Q

Excess Supply
HUTECH Institute of International Education

13


Why impose a price floor?
• To support prices (income) in important sectors of the
economy (eg. Agriculture).

• To protect workers (eg. minimum wages)

HUTECH Institute of International Education


A market with a price floor
(a) A price floor that is not binding
Price

(b) A price floor that is binding
Price

Surplus

Supply

Supply

$4

Price floor
3

$3

Equilibrium
price

Equilibrium
price

Price floor

2

Demand

Demand
Quantity
demanded

Equilibrium
quantity
0

100
Quantity of Ice-Cream Cones

➔ No effects on the price or quantity sold

HUTECH Institute of International Education

0

Quantity
supplied

120
80
Quantity of Ice-Cream Cones

➔ Binding price floor causes a surplus.

Control on Prices


The minimum wage
• 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 of
living

• If minimum wage – above equilibrium
– Unemployment
– Higher income - workers who have jobs
– Lower income - workers who cannot find jobs

16


The minimum wage

•If minimum wage is
above equilibrium
– Unemployment
– Raise income of
workers who have
jobs
– Lower income of
workers who cannot
find jobs

(b) A Labor Market with a
Binding Minimum Wage
Wage

Labor surplus
(unemployment)

Labor
supply

Minimum
wage
Labor
demand

0

Quantity
demanded

Quantity Quantity
supplied of Labor


The minimum wage
• 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 onthe-job training
• Minimum wage – binding
18


Evaluating Price controls
▪ Principle of Economics: “Markets are usually a
good way to organize economic activity”
- Economists usually oppose price ceilings and
price floors

• Prices are aim to balance supply and
demand – thereby coordinate economic
activity

HUTECH Institute of International Education

Control on Prices


Evaluating Price controls
▪ Principle of Economics: “Governments can
sometimes improve market outcomes”
- Impose price controls: because of unfair
market outcome
• Aimed at helping the poor
• Often hurt those they are trying to help
• Other ways of helping those in need
- Rent subsidies
- Wage subsidies
HUTECH Institute of International Education

Control on Prices


4.2 TAXES
▪ Government can make buyers or sellers pay tax.
▪ Tax can be a % of the good’s price, or a specific
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
HUTECH Institute of International Education

Control on Prices


Taxes on sellers
▪ Step 1: impact the sellers

→ shifts the S curve
▪ Step 2: the cost of producing increases
→ reduces the QS at every price
→ S curve shifts to the left

▪Step 3: Tax lead to higher P* and lower Q*

➔ Taxes reduce size of the market
HUTECH Institute of International Education

Control on Prices


Taxes on sellers
Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax

Equilibrium with tax

S2

S1

A tax on sellers
shifts the supply
curve upward
by the size of
the tax ($0.50).

$3.30
Tax
($0.50)

3.00

Equilibrium without tax

2.80

Price
sellers
receive

Demand, D1
0

90

100

Quantity of
Ice-Cream Cones

→ Tax discourage the market activity

→ Buyers pay more and sellers receive less
HUTECH Institute of International Education

Control on Prices


Taxes on buyers
▪ Step 1: impact the buyers
→ shifts the D curve
▪ Step 2: buying ice-cream become less attractive

→ reduces the QD at every price
→ D curve shifts downward to the left
▪Step 3: Tax lead to lower P* and lower Q*

➔ Taxes reduce size of the market
HUTECH Institute of International Education

Control on Prices


Taxes on buyers

Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax

Equilibrium with tax

Supply, S1
Equilibrium without tax
$3.30

A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).

Tax
($0.50)

3.00
2.80

Price
sellers

receive

D1

D2
0

90

100

Quantity of
Ice-Cream Cones

 Taxes levied on sellers and taxes levied on buyers are equivalent
HUTECH Institute of International Education

Control on Prices