Transcript Session8-SupplyDemandandGovernmentPolicies

Economic Analysis
for Business
Session VIII: Supply Demand and
Government Policies-I
Instructor
Sandeep Basnyat
9841892281
[email protected]
Government Policies That Alter the Private Market
Outcome

Price controls
◦ Price ceiling: a legal maximum on the price
of a good or service. Example: rent control.
◦ Price floor (Price support): a legal minimum
on the price of a good or service. Example:
minimum wage.
 Taxes
and Subsidies
◦ The govt. can make buyers or sellers pay a specific
amount on each unit bought/sold.
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
Price Control Policy : Rent Control in the Short
Run and Long Run
Rent controls are ceilings placed on the
rents that landlords may charge their
tenants.
 The goal of rent control policy is to help
the poor by making housing more
affordable.
 One economist called rent control “the
best way to destroy a city, other than
bombing.”

RENT CONTROL: The Market for Apartments
P
Rental
price of
apts
S
$800
Eq’m w/o
price
controls
D
300
Q
Quantity of
apartments
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
How Price Ceilings Affect Market Outcomes
A price ceiling
P
above the
$1000
eq’m price is
not binding –
it has no effect $800
on the market
outcome.
S
Price
ceiling
D
300
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
Q
How Price Ceilings Affect Market Outcomes
The eq’m price
P
($800) is above
the ceiling and
therefore illegal.
$800
The ceiling
is a binding
$500
constraint
on the price, and
causes
a shortage.
S
Price
ceiling
shortage
D
250
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
400
Q
How Price Ceilings Affect Market Outcomes
P
In the long run,
supply and
demand
are more
$800
price-elastic.
So, the shortage $500
is larger.
S
Price
ceiling
shortage
150
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
450
D
Q
CASE STUDY: Lines at the Gas Pump
In 1973, OPEC raised the price of crude
oil in world markets. Crude oil is the
major input in gasoline, so the higher oil
prices reduced the supply of gasoline.
 What was responsible for the long gas
lines?

•
Economists blame government regulations that limited
the price oil companies could charge for gasoline.
The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Price of
Gasoline
Supply, S1
1. Initially,
the price
ceiling
is not
binding . . .
Price ceiling
P1
Demand
0
Q1
Quantity of
Gasoline
The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Price of
Gasoline
S2
2. . . . but when
supply falls . . .
S1
P2
Price ceiling
3. . . . the price
ceiling becomes
binding . . .
P1
4. . . .
resulting
in a
shortage.
Demand
0
QS
QD Q1
Quantity of
Gasoline
PRICE FLOOR (PRICE SUPPORT) : The Market for
Unskilled Labor
Wage
paid to
unskilled
workers
W
S
$4
Eq’m w/o
price
controls
D
500
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
L
Quantity of
unskilled workers
How Price Floors Affect Market Outcomes?
A price floor
below the
eq’m price is
not binding –
it has no effect
on the market
outcome.
W
S
$4
Price
floor
$3
D
500
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
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How Price Floors Affect Market Outcomes
The eq’m wage ($4) W
is below the floor
$5
and therefore
illegal.
The floor
$4
is a binding
constraint
on the wage,
and causes
a surplus
(i.e., unemployment).
labor
surplus S
Price
floor
D
400
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
550
L
Case Study: The Minimum Wage

An important example of a price floor is
the minimum wage. Minimum wage laws
dictate the lowest price possible for labor
that any employer may pay.
The Minimum Wage
Min wage laws
do not affect
highly skilled
workers.
They do affect
teen workers.
Studies:
A 10% increase
in the min wage
raises teen
unemployment
by 1-3%.
W
unemployment S
Min.
wage
$5
$4
D
400
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
550
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Impact of Minimum Wage Laws
• Skills and Experience: No effects or not
binding because their equilibrium wage rates
are well above minimum wage
• Teenage labour: Least skilled and least
experienced. Minimum wage law hits them
hard.
• Impact on quantity of labour supplied:
Increases the quantity of labor supplied as
more teenagers will be interested to work, a
result of which they will drop out of schools.
Evaluating the Effects of Price Controls
 Prices are the signals that guide the
allocation of society’s resources. This
allocation is altered when policymakers
restrict prices.
 Price controls are often intended to help the
poor, but they often hurt more than help
them:
• The min. wage can cause job losses.
• Rent control can reduce the quantity and
quality of affordable housing.
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
Numerical Problems
Consider a market with Demand curve q = 16 − 10p and Supply curve
q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg)
(a) Determine the market equilibrium price and quantity and the total
revenue in this market.
(b) Calculate the price elasticity of demand and the price elasticity of
supply at the market equilibrium.
Solved Problems
Consider a market with Demand curve q = 16 − 10p and Supply
curve q = −8 + 20p. (Here q is in millions of kgs and p is in
dollars per kg.)
(a) Determine the market equilibrium price and quantity and the
total revenue in this market.
 Simultaneously solving the demand and supply equations:
p = $0.80 per kg. and q = 8 million kgs.
Total revenue is: p x q = 0.8 x 8 = $6.4 millions.
(b) Calculate the price elasticity of demand and the price
elasticity of supply at the market equilibrium.
The slope of the demand curve is −10, so the price elasticity of
demand at the market equilibrium is −10.(0.8/8) = −1.
Similarly, the slope of the supply curve is 20, so the price
elasticity of supply at the market equilibrium is 20.(0.8/8)= 2.
Numerical Problems
Consider a market with Demand curve q = 16 − 10p and Supply curve
q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg)
c) Suppose the government sets support price of $1 per kg in this
market and purchases the surplus at support price. Find the
quantity demanded, quantity supplied and government
expenditure in this market to implement the policy.
d) Illustrate in diagram the results obtained in part (c).
Numerical Problems
Consider a market with Demand curve q = 16 − 10p and Supply curve
q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg)
c) Suppose the government sets support price of $1 per kg in this
market and purchases the surplus at support price. Find the
quantity demanded, quantity supplied and government
expenditure in this market to implement the policy.
At, support price of $1/kg,
Quantity demanded = 16 – 10(1) = 6 million kgs.
Quantity Supplied = - 8 + 20(1) = 12 million kgs.
There will be a surplus of 6 million kgs in the market.
Total Government expenditure = 6 x 1 = $6 million.
(d) Illustration of part c on Price Support Policy
W
Surplus = 6
million kgs.
S
Price support
(floor)
$1
$0.8
Govt.
Spend
ing
D
6
8 12
CHAPTER 6 SUPPLY,
DEMAND, AND
GOVERNMENT POLICIES
L
Thank you