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Supply, Demand & Government Policies

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The document discusses how government policies like price controls, price floors and ceilings, and taxes can impact supply and demand equilibrium in a market. It explains that price controls can result in shortages or surpluses if the price is set below or above the market equilibrium price. Taxes on goods lead to a smaller quantity sold as the tax burden is shared between buyers and sellers through a change in the market equilibrium.

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Supply, Demand & Government Policies Lecture 5
In a free market system, market forces establish equilibrium prices and exchange quantities. One of the roles of economists is to develop theories to assist in the development of policies.
Controls on Prices Buyers always want lower prices, while sellers want higher prices. Thus, interests of these two groups conflict. Controls on prices are usually enacted when policymakers believe the market price is unfair to buyers or sellers. For this government creates price ceilings and price floors.
Controls on Prices Cont Price Ceiling: A legal maximum on the price at which a good can be sold. Price Floor: A legal minimum on the price at which a good can be sold.
Controls on Prices Cont How Price Ceilings Affect Market Outcomes: When govt. imposes price ceiling, following two outcomes are possible: 1. If price is set above the equilibrium price, price ceiling is not binding . Price ceiling has no effect on the price or quantity sold .
Price Ceiling that is NOT BINDING Price Supply P2 Price Ceiling P1 Equilibrium Price Demand 0 Q Quantity Equilibrium Quantity
Controls on Prices Cont How Price Ceilings Affect Market Outcomes (Cont.): 2. If price is set below the equilibrium price, price ceiling is a binding constraint. The forces of demand and supply move price towards equilibrium price. But when market price hits the ceiling, it can rise no further. Thus, market price equals price ceiling. At this price, quantity demanded exceeds quantity supplied, creating shortage for the good.
Price Ceiling that is BINDING Price Supply Equilibrium Price P2 P1 Price Shortage Ceiling Demand 0 Q1 Q2 Quantity Quantity Quantity Supplied Demanded
Controls on Prices Cont How Price Ceilings Affect Market Outcomes (Cont.): Therefore, when government imposes a binding price ceiling on a market, shortage of the good arises
Controls on Prices Cont How Price Floors Affect Market Outcomes: When govt. imposes price floor, following two outcomes are possible: 1. If price is set below the equilibrium price, price floor is not binding . Price floor has no effect on the price or quantity sold .
Price Floor that is NOT BINDING Price Supply Equilibrium Price P2 Price Floor P1 Demand 0 Q Quantity Equilibrium Quantity
Controls on Prices Cont How Price Floors Affect Market Outcomes (Cont.): 2. If price is set above the equilibrium price, price floor is a binding constraint. The forces of demand and supply move price towards equilibrium price. But when market price hits the floor, it can fall no further. Thus, market price equals price floor. At this price, quantity supplied exceeds quantity demanded, causing surplus for the good.
Price Floor that is BINDING Price Supply Surplus P2 Price Floor P1 Equilibrium Price Demand 0 Q1 Q2 Quantity Quantity Quantity Demanded Supplied
Taxes Governments use taxes to raise revenue for public projects, such as for: Roads Schools National defense Taxes affect market activity. When a good is taxed, the quantity sold is smaller.
Taxes Cont Important Question When govt. levies tax on a good, who bears the burden of the tax? Buyers Or Sellers
Taxes Cont Economists use the term tax incidence to refer to the distribution of tax burden. Tax incidence is the manner in which the burden of a tax is shared among participants in a market.
Taxes Cont Taxes result in a change in market equilibrium. Buyers pay more and sellers receive less, regardless of whom the tax is levied on.
Taxes Cont What is the impact of tax? Taxes discourage market activity. When a good is taxed, the quantity sold is smaller. Buyers and sellers share the tax burden.

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Supply, Demand & Government Policies

  • 1. Supply, Demand & Government Policies Lecture 5
  • 2. In a free market system, market forces establish equilibrium prices and exchange quantities. One of the roles of economists is to develop theories to assist in the development of policies.
  • 3. Controls on Prices Buyers always want lower prices, while sellers want higher prices. Thus, interests of these two groups conflict. Controls on prices are usually enacted when policymakers believe the market price is unfair to buyers or sellers. For this government creates price ceilings and price floors.
  • 4. Controls on Prices Cont Price Ceiling: A legal maximum on the price at which a good can be sold. Price Floor: A legal minimum on the price at which a good can be sold.
  • 5. Controls on Prices Cont How Price Ceilings Affect Market Outcomes: When govt. imposes price ceiling, following two outcomes are possible: 1. If price is set above the equilibrium price, price ceiling is not binding . Price ceiling has no effect on the price or quantity sold .
  • 6. Price Ceiling that is NOT BINDING Price Supply P2 Price Ceiling P1 Equilibrium Price Demand 0 Q Quantity Equilibrium Quantity
  • 7. Controls on Prices Cont How Price Ceilings Affect Market Outcomes (Cont.): 2. If price is set below the equilibrium price, price ceiling is a binding constraint. The forces of demand and supply move price towards equilibrium price. But when market price hits the ceiling, it can rise no further. Thus, market price equals price ceiling. At this price, quantity demanded exceeds quantity supplied, creating shortage for the good.
  • 8. Price Ceiling that is BINDING Price Supply Equilibrium Price P2 P1 Price Shortage Ceiling Demand 0 Q1 Q2 Quantity Quantity Quantity Supplied Demanded
  • 9. Controls on Prices Cont How Price Ceilings Affect Market Outcomes (Cont.): Therefore, when government imposes a binding price ceiling on a market, shortage of the good arises
  • 10. Controls on Prices Cont How Price Floors Affect Market Outcomes: When govt. imposes price floor, following two outcomes are possible: 1. If price is set below the equilibrium price, price floor is not binding . Price floor has no effect on the price or quantity sold .
  • 11. Price Floor that is NOT BINDING Price Supply Equilibrium Price P2 Price Floor P1 Demand 0 Q Quantity Equilibrium Quantity
  • 12. Controls on Prices Cont How Price Floors Affect Market Outcomes (Cont.): 2. If price is set above the equilibrium price, price floor is a binding constraint. The forces of demand and supply move price towards equilibrium price. But when market price hits the floor, it can fall no further. Thus, market price equals price floor. At this price, quantity supplied exceeds quantity demanded, causing surplus for the good.
  • 13. Price Floor that is BINDING Price Supply Surplus P2 Price Floor P1 Equilibrium Price Demand 0 Q1 Q2 Quantity Quantity Quantity Demanded Supplied
  • 14. Taxes Governments use taxes to raise revenue for public projects, such as for: Roads Schools National defense Taxes affect market activity. When a good is taxed, the quantity sold is smaller.
  • 15. Taxes Cont Important Question When govt. levies tax on a good, who bears the burden of the tax? Buyers Or Sellers
  • 16. Taxes Cont Economists use the term tax incidence to refer to the distribution of tax burden. Tax incidence is the manner in which the burden of a tax is shared among participants in a market.
  • 17. Taxes Cont Taxes result in a change in market equilibrium. Buyers pay more and sellers receive less, regardless of whom the tax is levied on.
  • 18. Taxes Cont What is the impact of tax? Taxes discourage market activity. When a good is taxed, the quantity sold is smaller. Buyers and sellers share the tax burden.