Download Lecture VI: Supply and Demand in Practice

Lecture VI: Supply and Demand in Practice
I. Price Controls
A. Price Ceiling
i. in theory
Price Ceiling – an upper limit set on a price
P
Supply Curve (S)
Not binding
PC
Excess demand - shortage
PE
Binding
PC
Demand Curve (D)
Q
QD*
QE
QS*
- if set above equilibrium, not binding
- if set below equilibrium, it is binding
Binding – a price control is said to be “binding” or effective if it keeps the price in the
market from reaching the equilibrium price level
Results of a binding price ceiling is a SHORTAGE
- the government is the economic agency that can legally set price controls
and hinder the natural market processes
ii. Application – rent control
IMPACT of Binding Rent Controls
a. - shortage – excess demand
b. - black markets or underground market transactions
c. - entrance fees – people getting kicked out a lot
d. - higher search costs for apartments since there is a shortage
e. - declines in the quality and maintenance of rental housing
f. - large deserted apartment complexes in inner cities
g. - future supply will decline – no incentive for new construction
h. – the creation of a rent control regulator commission
B. Price Floor – a lower limit set on a price
i. in theory
P
Supply Curve (S)
Binding
PF
Excess supply - surplus
PE
Not Binding PF
Demand Curve (D)
Q
QD*
QE
QS*
- if set above equilibrium, binding
Results in a surplus
ii. an application – the minimum wage
8/98 Congress passed a law to raise the minimum wage to $5.25
Impact of Price Floors
II. Excise Taxes – a tax imposed on some specific good
When these taxes are imposed on imported goods they are called tariffs
Tariff – a tax on some specific imported good
Consider a standard supply/demand framework for luxury boats in the US
P
$70,000
$65,000
(S1)
(S0)
$10,000
$60,000
(D)
Q
QET QE
- suppose that an excise tax of $10,000 per boat is imposed by the government and
collected from the supplier
- the producer will view this tax as a $10,000 increase in the cost of production
- the supply curve will shift up by $10,000, the direction of the price (the vertical axis)
- if the initial equilibrium price is $60,000, the producer would like the new equilibrium
price to be $70,000 so they can pass the entire amount of the tax to the consumer
- but with the interaction of supply and demand, the new equilibrium turns out to be at
$65,000. This means only half of the tax burden could be passed off to consumers
- the tax results in a higher equilibrium price and a lower equilibrium quantities
III. Quotas – sometimes the gov’t alters the market process by limiting the amount of
foreign goods that can be imported into the US
Quota: a quantitative restriction on the amount that one country can export to
another
P
Quota
(S0)
PQ
Surplus (?)
PmE
(D)
Q
QQ QE
A quota acts as a fence that prevents the market from moving to the right on the quantity
axis
RESULT:
A higher price than market equilibrium
A lower quantity than market equilibrium