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Chapter 6 To begin with … 6.1Price ceiling 6.2Price floor 6.3Quantity control: quota Market intervention (I) 1.

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Presentation on theme: "Chapter 6 To begin with … 6.1Price ceiling 6.2Price floor 6.3Quantity control: quota Market intervention (I) 1."— Presentation transcript:

1 Chapter 6 To begin with … 6.1Price ceiling 6.2Price floor 6.3Quantity control: quota Market intervention (I) 1

2 Chapter 6 To begin with … 2 We have learned that: The equilibrium price and quantity of a good are determined by market demand and market supply in a free market. 0 Q P S D P0P0 Q0Q0

3 Chapter 6 To begin with … 3 In this chapter, we will study the situations under which the government intervenes in the market. Common types of government intervention Price ceilingPrice floor Price controlQuantity control Quota Unit tax Unit subsidy Scope of this chapter

4 Chapter 6 4 Task 6.1 A nuclear leak has occurred at the nuclear plant of City J. City H is close to City J. There is a rumour that salt can prevent radiation poisoning. City J City H Salt 100g Price = $1,000 per pack The price of salt has soared to $1,000 per pack (100 g). The government passes an emergency act to ban sellers selling salt from charging more than $10 per pack. Price = $10 per pack

5 Chapter 6 A poor housewife 5 Task 6.1 Before the act, we could buy very little salt because the price was so high. Since the act has been passed, we can still only buy very little salt because now theres a shortage. A rich man who is a salt lover The government should not intervene in the market! Before the ban, I could buy salt easily. Now it is difficult to get it!

6 Chapter 6 6 Task How has the act affected the salt retailing market? Price? Quantity transacted? Total revenue? Price, quantity transacted and total revenue have all decreased.

7 Chapter 6 7 Task Under such a circumstance, would you support the act? For whom to produce? Economic reasons versus political reasons

8 Chapter 6 8 Task Suppose you were the rich man. Try to think of a method for getting the amount of salt you want. Free answer. For example: Buying salt in the black market at a higher price. Can you suggest more methods?

9 Chapter 6 6.1Price ceiling 9

10 Chapter 6 6.1Price ceiling Maximum price allowed by the government 10 To ensure the public can consume some necessities at affordable prices Example: Rent control from 1947 to 1998 in HK Why imposes a price ceiling? Think about the case in Task 6.1.

11 Chapter 6 0 Q P S D P1P1 0 Q P S D P2P2 Fig. A Fig. B 6.1Price ceiling Effective or not? 11 Effective only if it is imposed below the equilibrium price P0P0 Q0Q0 P0P0 Q0Q0 Which one is effective?

12 Chapter 6 Fig. 6.1 A.Effects on price and quantity 12 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.1 What are the equilibrium price and quantity? The market equilibrium is achieved when the market quantity demanded is equal to market quantity supplied at the same price. The equilibrium quantity and price are 12 units and $3, respectively. 0 Q P S D

13 Chapter 6 Fig. 6.1 A.Effects on price and quantity 13 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D Suppose the government imposes a pricing ceiling of $2 on the good. What will the new price and the new quantity transacted be? As the maximum price ($2) is lower than the original equilibrium price ($3), the price ceiling is effective. Thus, the new price will be $2. Price ceiling 2

14 Chapter 6 Fig. 6.1 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) A.Effects on price and quantity 14 Table Q P S D At the controlled price of $2, Q d = 16 units and Q S = 8 units. Price ceiling 2 Whenever Q d is not equal to Q S, only the smaller of the two quantities can be traded. = Q t 8

15 Chapter 6 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) A.Effects on price and quantity 15 Table Q P S D Fig. 6.1 At the controlled price ($2), Q d = 16 units and Q S = 8 units. Price ceiling 2 Whenever Q d is not equal to Q S, only the smaller of the two quantities can be traded. = Q t 8 When an effective price ceiling is imposed, the quantity transacted is equal to the quantity supplied.

16 Chapter 6 Fig. 6.1 A.Effects on price and quantity 16 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D At the controlled price ($2): Q d > Q S Shortage Price ceiling

17 Chapter 6 Fig. 6.1 B.Effects on total expenditure and total revenue 17 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D The effective price ceiling leads to a movement along the supply curve from Point A to Point B. Price ceiling A B

18 Chapter 6 Fig. 6.1 B.Effects on total expenditure and total revenue 18 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D Price ceiling Consumers total expenditure and producers total revenue: Before the imposition of the price ceiling = $3 × 12 = $36 After the imposition of the price ceiling = $2 × 8 = $16 Decrease! A B

19 Chapter 6 Effects of an effective price ceiling 19 To conclude, an effective price ceiling has the following effects: 1.The market price decreases. 2.A shortage or excess demand is created. 3.The quantity transacted decreases. 4.Producers total revenue (or consumers total expenditure) decreases. Why must producers total revenue decrease under an effective price ceiling? Answers will be provided in the final version.

20 Chapter 6 Test yourself 6.1 Suppose the equilibrium price of a return air ticket between Hong Kong and London is $10,000. If the government does not allow airline companies to sell the air ticket for more than $5,000, what effects will there be on the price and quantity transacted of air tickets? What will happen to the total revenue of airline companies? 20

21 Chapter 6 Test yourself 6.1 (cont) Answer: S D 10,000 5,000 Q1Q1 Q2Q2 Maximum price Price ($ / unit) Quantity (units / period) 0 21 decrease The price of air tickets will decrease to $5,000. The quantity transacted of air tickets will. The total revenue of airline companies will increase / decrease / remain unchanged.

22 Chapter 6 C.How to deal with a shortage that results from a price ceiling 22 Due to the excess demand under a effective price ceiling, buyers have to compete with each other by 1.non-price competition; or 2.price competition.

23 Chapter 6 C.How to deal with a shortage that results from a price ceiling 23 1.Non-price competition among buyers Buyers may need to meet certain criteria or use other means to get the good, including a.first-come, first-served (queuing); b.by luck (e.g., drawing lots); c.by need; or d.other criteria, such as producers preference, friendship, age, height, etc.

24 Chapter 6 C.How to deal with a shortage that results from a price ceiling 24 2.Price competition among buyers a.Extra fees Buyers may be asked to pay extra fee (legally or illegally) before they buy the good. Examples: Membership fee Entrance fee Key money

25 Chapter 6 C.How to deal with a shortage that results from a price ceiling 25 b.Black market In a black market, goods are sold at prices higher than the legal maximum. In the previous example, buyers are willing to pay up to $4 per unit on the black market at the quantity transacted of 8 units. 0 Q P S D Shortage Price ceiling 2.Price competition among buyers

26 Chapter 6 Learning tips 6.1Ineffective price ceiling A price ceiling is ineffective when it is imposed above the equilibrium price. 26 No effect on the price, quantity transacted and total revenue No excess demand PePe 0 Q P S D P1P1 Price ceiling Total revenue QeQe

27 Chapter 6 Learning tips 6.1Ineffective price ceiling A price ceiling is ineffective when it is imposed above the equilibrium price. 27 Suppose the price ceiling is now set at $4. Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.1 As the price ceiling is ineffective, the market price and the quantity transacted will stay at $3 and 12 units.

28 Chapter 6 Learning tips 6.1Ineffective price ceiling Real-life example: Tunnel tolls at the Western Harbor Tunnel 28 Vehicle Effective from 31 July 2013 Gazetted toll (HK$) Actual toll (HK$) Motorcycles 9025 Private cars Taxis Public and private light buses Table 6.2 Gazetted and actual tolls at the Western Harbour Tunnel

29 Chapter 6 Discuss 6.1 Why has the Hong Kong Government set an ineffective price ceiling on tolls for the Western Harbour Tunnel? Discuss in groups the possible reasons. 29 Back in the early 1990s, the Government wanted to attract private companies to build and operate the Western Harbour Tunnel, so it allowed the successful company to raise tolls (i.e., the price ceiling) when the actual revenue was below the forecast level. However, the tunnel company noticed that its total revenue would be maximised when the tolls are set below the price ceiling (at the mid-point of the demand curve where the demand elasticity is equal to one), hence the price ceiling becomes ineffective.

30 Chapter 6 Test yourself 6.2 Based on the following diagrams, indicate the price, quantity transacted and total revenue after the imposition of a price ceiling Q P S D P1P1 0 Q P S D P1P1 a. P0P0 Q0Q0 P0P0 Q0Q0 b. Q1Q1 Q2Q2 Q1Q1 Q2Q2 Price ceiling

31 Chapter 6 Learning tips 6.2 How does the change in demand or supply affect the effectiveness of price ceiling? Suppose the government has imposed an effective price ceiling. The price ceiling will become ineffective if the equilibrium price drops below the maximum price allowed. 31 PePe 0 Q P S D2D2 P1P1 Price ceiling QeQe D1D1 Q1Q1 This can be caused by: (a) A decrease in demand

32 Chapter 6 Learning tips 6.2 (cont) How does the change in demand or supply affect the effectiveness of price ceiling? 32 PePe 0 Q P S2S2 D P1P1 QeQe S1S1 Q1Q1 Suppose the government has imposed an effective price ceiling. The price ceiling will become ineffective if the equilibrium price drops below the maximum price allowed. This can be caused by: (b) An increase in supply Price ceiling

33 Chapter 6 Economics at work 6.1 Effects of rent control on residential units Hong Kong had a rent control before This resulted in excess demand of rental units. 33 Non-price methods had to be used to allocate the limited number of rental units. For example, allocation may be based on tenants family status or jobs. Some landlords require key money before tenants get a rental contract. Fig. 6.7 Under rent control, conditions in residential units tend to deteriorate.

34 Chapter 6 Economics at work 6.1 (cont) Effects of rent control on residential units Other effects of rent control: 34 Tenants are reluctant to move out. Landlords have little incentive to maintain their flats. Conditions in the flats deteriorate.

35 Chapter 6 Test yourself 6.3 Does rent control imposed on old private residential flats benefit the tenants? Explain with the aid of a diagram. 35 Answer: Tenants who have already rented their flats can / cannot benefit from rent control as they now pay a lower / higher rent. 0 Q P S D P1P1 PePe QeQe Q1Q1 Q2Q2 Price ceiling Excess demand

36 Chapter 6 Test yourself 6.3 (cont) Does rent control imposed on old private residential flats benefit the tenants? Explain with the aid of a diagram. 36 Answer: However, since landlords are more / less willing to rent out their flats, potential tenants can rent flats more / less easily. non-price competitionPotential tenants have to engage in __________________ and even pay a higher / lower black market rent to landlords. Therefore, potential tenants may not benefit from rent control.

37 Chapter 6 Test yourself 6.3 (cont) Does rent control imposed on old private residential flats benefit the tenants? Explain with the aid of a diagram. 37 Answer: Since rent control limits the rental income received by landlords, they lack an incentive to maintain the quality of their flats. So, there will be deterioration in the quality of rental flats in the market. Therefore, tenants as a whole suffer from a decrease in the quality of rental flats.

38 Chapter 6 Test yourself 6.4 a.Apart from family status and income status, suggest TWO other methods for allocating the limited number of rental units under rent control. 38 Answer: first-come, first-served relationships or friendships with landlords age any other possible reasons

39 Chapter 6 Test yourself 6.4 (cont) b.If there is rent control, what effect would this have on the turnover rate of rental units? Explain your answer. 39 Answer: shortage reluctant Under rent control, _______ of private rental units exists. The tenants are paying a rent which is higher / lower than the equilibrium level. They are _______ to move out. Therefore, the turnover rate will increase / decrease.

40 Chapter 6 Discuss 6.2 In recent years, as the rent for private residential housing has risen rapidly, more and more people have urged the Hong Kong Government to impose rent controls again. Discuss in groups the pros and cons of imposing rent controls on private residential housing. 40 The poor can pay a lower rent To the tenants, l andlords cannot charge excessive rents Fairer to the tenants Cons: Pros: A shortage of rental housing units L andlords will lack incentives to maintain the buildings I nfringe private property rights

41 Chapter 6 Past exam Q 1.Suppose the government imposed an effective price ceiling on good X. If the government raises the price ceiling, the total consumer expenditure on good X 41 A.would increase. B.would decrease. C.would remain unchanged. D.may increase, decrease or remain unchanged depending on the elasticity of demand. (HKCEE 2009, Q8)

42 Chapter 6 Past exam Q 2.Suppose the government introduces an effective rent control which sets a maximum rental per square feet the landlords can charge to any tenants. Which of the following statements is correct? 42 A.(1) and (2) only B.(1) and (3) only C.(2) and (3) only D.(1), (2) and (3) (HKDSE 2013, Q15) (1)There will be a shortage of rental units. (2)The landlords will have less incentive to rent out their flats. (3)The landlords will spend less on maintenance of the rental flats.

43 Chapter 6 6.2Price floor 43

44 Chapter 6 44 Task 6.2 There are many rice farmers in Country T. Due to the countrys abundant supply of rice, the market price is low. In order to protect the income of rice farmers, the government has set a minimum price which is above the market price for rice. Consumers must pay at or above the minimum price to buy rice. Country T

45 Chapter 6 A rice farmer 45 Task 6.2 Im not sure whether the limit can help me. I cant sell as much as I produce. A consumer With the price limit, I cant buy rice as cheaply as before. So, Im consuming more of other types of staple food and less rice now.

46 Chapter 6 46 Task Why cant the farmer sell as much as he produces when there is a price limit? QS?QS? Qd?Qd? When the price is set higher than the equilibrium, the quantity demanded of rice will be smaller than the quantity supplied.

47 Chapter 6 47 Task As a consumer, would you support the price limit? Price? Free answer. Suggested answer: No, I need to pay higher price.

48 Chapter 6 48 Task As a rice farmer, would you support the price limit? Total revenue? Free answer. Suggested answer: Yes, only if I can sell rice at the higher price. If there is a surplus, some farmers may not be able to sell their products and their total revenue may fall (which depends on price elasticity of demand)

49 Chapter 6 6.2Price floor Minimum price allowed by the government 49 To protect the income of some parties or to encourage local production. Example: Minimum wage in Hong Kong Why imposes a price floor?

50 Chapter 6 0 Q P S D P1P1 0 Q P S D P2P2 Fig. A Fig. B 6.2Price floor Effective or not? 50 Effective only if it is imposed above the equilibrium price P0P0 Q0Q0 P0P0 Q0Q0 Which one is effective?

51 Chapter 6 A.Effects on price and quantity 51 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.3 Again, the original quantity and price are 12 units and $3, respectively. 0 Q P S D Fig

52 Chapter 6 Fig A.Effects on price and quantity 52 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D Suppose the government imposes a pricing floor of $4 on the good. What will the new price and the new quantity transacted be? As the minimum price ($4) is higher than the original equilibrium price ($3), the price floor is effective. The new price will be $4. Price floor

53 Chapter 6 Fig A.Effects on price and quantity 53 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.3 At the controlled price ($4), Q d = 8 units and Q S = 16 units. Whenever Q d is not equal to Q S, only the smaller of the two quantities can be traded. 0 Q P S D Price floor = Q t 8 When an effective price floor is imposed, the quantity transacted is equal to the quantity demanded.

54 Chapter 6 Fig A.Effects on price and quantity 54 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.3 At the controlled price of $4: 0 Q P S D Price floor Surplus Q d < Q S Surplus

55 Chapter 6 Fig Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D Price floor The effective price ceiling leads to a movement along the demand curve from Point A to Point C. B.Effects on total expenditure and total revenue A C

56 Chapter 6 Fig Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table Q P S D Price floor Consumers total expenditure and producers total revenue: Before the imposition of the price floor = $3 × 12 = 36 After the imposition of the price floor = $4 × 8 = 32 In this case, both TE and TR decrease. B.Effects on total expenditure and total revenue A C

57 Chapter 6 B.Effects on total expenditure and total revenue 57 The effect of a price floor on total revenue depends on the elasticity between the original price and the minimum price: If demand is inelastic (i.e., E d < 1), then total revenue will increase. Gain Loss > 0 Q D S Price floor P Q1Q1 Q2Q2 P1P1 P2P2

58 Chapter 6 58 The effect of a price floor on total revenue depends on the elasticity between the original price and the minimum price: If demand is elastic (i.e., E d > 1), then total revenue will decrease. B.Effects on total expenditure and total revenue Gain Loss < 0 Q D S Price floor P Q1Q1 Q2Q2 P1P1 P2P2

59 Chapter 6 59 The effect of a price floor on total revenue depends on the elasticity between the original price and the minimum price: If demand is unitarily elastic (i.e., E d = 1), then total revenue will remain unchanged. B.Effects on total expenditure and total revenue Gain Loss = 0 Q D S Price floor P Q1Q1 Q2Q2 P1P1 P2P2

60 Chapter 6 Effects of an effective price floor 60 To conclude, an effective price floor has the following effects: 1.The market price increases. 2.A surplus or excess supply is created. 3.The quantity transacted decreases. 4.Producers total revenue (or consumers total expenditure) may increase, decrease or remain unchanged. This depends on the elasticity of demand between the original equilibrium price and the minimum price.

61 Chapter 6 Test yourself 6.5 Suppose the equilibrium price of a return air ticket between Hong Kong and London is $10,000. If the government does not allow airline companies to sell the air ticket for less than $15,000, what effects will this have on the price and quantity transacted of air tickets? What will happen to the total revenue of airline companies? 61

62 Chapter 6 The price of air tickets will increase to $15,000. The quantity transacted of air tickets will. The total revenue of airline companies may increase, decrease or remain unchanged, depending on the. Test yourself 6.5 (cont) Answer: S D 10,000 15,000 Q1Q1 Q2Q2 Minimum price Price ($ / unit) Quantity (units / period) 0 62 decrease price elasticity of demand

63 Chapter 6 C.How to deal with the surplus that results from a price floor 63 Due to the excess supply under a effective price floor, sellers have to compete with each other by 1.non-price competition; or/and 2.price competition.

64 Chapter 6 C.How to deal with the surplus that results from a price floor 64 1.Non-price competition among sellers Sellers may need to meet certain criteria or use other means to sell their good, including For example, when a minimum wage is imposed, workers (especially the low-skilled) have to invest more resources to acquire more skills, e.g., attending training courses. a.Improving the quality of goods; b.Providing extra gifts or services; c.other criteria, such as buyers preference, friendship, seniority, height, strength, etc.

65 Chapter 6 C.How to deal with the surplus that results from a price floor 65 2.Price competition among sellers a.Extra fees Sellers may be asked to pay buyers (or middlemen) legally or illegally an extra fee in order to have priority over others in selling their goods.

66 Chapter 6 P 0 Q S D C.How to deal with the surplus that results from a price floor 66 2.Price competition among sellers b.Illegal price cutting (or illegal price concession) Suppliers may sell their goods at prices lower than the legal minimum. In the previous example, suppliers are willing to sell illegally at $2 per unit when the quantity transacted is 8 units. Surplus Price floor

67 Chapter 6 Learning tips 6.3Ineffective price floor A price floor is ineffective when it is imposed below the equilibrium price. 67 No effect on the price, quantity transacted and total revenue No excess supply PePe 0 Q P S D P1P1 Price floor QeQe Total revenue

68 Chapter 6 Test yourself 6.6 Based on the following diagrams, indicate the price, quantity transacted and total revenue after the imposition of a price floor Q P S D P0P0 0 Q P S D P0P0 a. P1P1 Q1Q1 P1P1 Q1Q1 b. Q0Q0 Q2Q2 Q0Q0 Q2Q2 Price floor

69 Chapter 6 Test yourself 6.7 With reference to Learning tips 6.2, explain how the change in demand or supply affects the effectiveness of price floor. 69

70 Chapter 6 Test yourself 6.7 (cont) 70 Answer: When there is an increase in demand or a decrease in supply, the price floor will become ineffective if the new equilibrium price is higher than the minimum price imposed. This can be caused by: (a) A increase in demand PePe 0 Q P S D1D1 P1P1 Price floor QeQe D2D2 Q1Q1 (b) A decrease in supply PePe 0 Q P S1S1 D P1P1 Price floor Q1Q1 S2S2 QeQe

71 Chapter 6 Economics at work 6.2 Exploitation of workers under the minimum wage The minimum wage law was implemented in Hong Kong on 1 May After the implementation, cases of worker exploitation, especially of older workers, were occasionally discovered. 71 Excess supply of labour exists in some industries. Employers tend to hire younger workers with more skills and higher productivity. To avoid losing their jobs to younger workers, some older and low-skilled workers are forced to accept wages that are lower than the statutory minimum level.

72 Chapter 6 Economics at work 6.2 (cont) Exploitation of workers under the minimum wage 72

73 Chapter 6 Test yourself 6.8 Can a minimum wage law help low-wage, unskilled workers in Hong Kong to earn a larger total income? Explain with the aid of a diagram. 73 Answer: P1P1 0 Q P S D1D1 PePe Minimum wage QeQe Q1Q1 Q2Q2 Surplus A minimum wage will raise / reduce employment of workers. Workers who can still secure employment after the introduction of the minimum wage would benefit / suffer from the higher / lower wage rate.

74 Chapter 6 Test yourself 6.8 (cont) Can a minimum wage law help low-wage, unskilled workers in Hong Kong to earn a larger total income? Explain with the aid of a diagram. 74 Answer: P1P1 0 Q P S D1D1 PePe Minimum wage QeQe Q1Q1 Q2Q2 Surplus However, since the minimum wage creates an excess demand / supply of labour (Q 2 – Q 1 ), employers can be more selective in choosing employees. They tend to employ workers with more skills and higher productivity. Some workers, mainly those who are unskilled or with lower productivity, are unemployed.

75 Chapter 6 Test yourself 6.8 (cont) 75 Answer: Moreover, workers must compete among themselves to be employed. They have to engage in non-price competition (e.g., attending self-financed training courses). Some workers may need to agree to an illegal wage cut proposed by employers to become employed. Therefore, potential employees may not benefit from the minimum wage.

76 Chapter 6 Test yourself 6.9 Why are old watchmen and exploited domestic helpers willing to receive wages lower than the statutory minimum? 76 Answer: They are afraid of losing their jobs to young workers. Old workers can easily / hardly get recruited when they are unemployed.

77 Chapter 6 Discuss 6.3 Some employers offer to pay their watchmen or foreign domestic helpers wages that are higher than the statutory minimum. Why would this happen? Is it just because those employers are kind to their employees? 77 Free answer. Perhaps these employers find that the workers are more productive and deserve a wage higher than the statutory minimum. Any other reasons?

78 Chapter 6 Discuss 6.4 There is only one minimum wage for all sectors in Hong Kong. Discuss in which sectors the minimum wage is most likely to be effective and how it affects those sectors. 78 Free answer. It is most likely that the minimum wage is effective for cleaning and security industries. Since cleaners and watchmen are unskilled, employers will pay lower wages to them if there is no minimum wage law.

79 Chapter 6 Past exam Q Refer to the above diagram. Which of the following statements is correct? A.If a price ceiling is set at P 1, the quantity transacted is Q 3. B.If a price floor is set at P 1, the quantity transacted is Q 2. C.If a price floor is set at P 3, the quantity transacted is Q 2. D.If a price ceiling is set at P 3, non-price competition will occur. (HKCEE 2004, Q12)

80 Chapter 6 Past exam Q 4.Suppose in Hong Kong there is an excess supply of Filipina domestic helpers at the minimum wage (w) set by the government. Also suppose that recently Hong Kong employers have to purchase an additional insurance policy for newly hired Filipina domestic helpers. Which of the diagrams on the right correctly reflects the above situation in the Filipina domestic helpers market in Hong Kong? 80 (HKCEE 2011, Q7)

81 Chapter 6 6.3Quantity control: quota 81

82 Chapter 6 82 Task 6.3 Traffic congestion is serious in Beijing. Starting from 2011, the Beijing government has set a limit on the number of new vehicle licences issued each month in an effort to solve the problem. A 20000

83 Chapter 6 Miss Li (Car agent) 83 Task 6.3 The number of new vehicles transacted has decreased greatly. What should I do? Mr Chen I want to buy a new car. The number of new vehicle licences issued per month is 20,000 but there are more than 50,000 applications. We need to wait for the result from the drawing of lots.

84 Chapter 6 84 Task Since the new policy, in which form of competition has Mr Chen engaged? Waiting? He has engaged in non-price competition.

85 Chapter 6 85 Task What should Miss Li do to raise her revenue from selling cars? Change the prices? Any other ways? Improve quality?

86 Chapter 6 86 Task Suggest other methods that can reduce the number of new private cars on the roads. Raising the first registration fee Increasing annual licence fee Raising fuel tax Many other ways! Introducing electronic-road pricing

87 Chapter 6 6.3Quota Maximum amount of output that the government allows 87 Many reasons. For example: Two-can limit on baby formula to deal with milk shortage fear. Restricted number of taxis and minibuses to reduce traffic congestion. Why imposes a quota?

88 Chapter 6 0 Q P S D 0 Q P S D Fig. A Fig. B 6.3Quota Effective or not? 88 Effective only if it is imposed below the equilibrium quantity P0P0 Q0Q0 P0P0 Q0Q0 Which one is effective?

89 Chapter 6 A.Effects on price and quantity 89 Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.4 Again, the original quantity and price are 12 units and $3, respectively. 0 Q P S D Fig. 6.16

90 Chapter 6 Fig Market Q S under quota (units / week) A.Effects on price and quantity 90 0 Q P S D Suppose the government imposes a quota of 8 units on the good. What will the new price and the new quantity transacted be? The maximum amount the producers can sell is only 8 units. The new price and the new quantity transacted will be $4 and 8 units, respectively. Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.4 The supply curve becomes kinked. S

91 Chapter 6 Fig Market Q S under quota (units / week) B.Effects on total expenditure and total revenue 91 The effective quota leads to a movement along the demand curve from Point A to Point H. 0 Q P S D Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.4 S A H

92 Chapter 6 Fig Market Q S under quota (units / week) B.Effects on total expenditure and total revenue 92 Before the imposition of the quota = $3 × 12 = 36 After the imposition of the quota = $4 × 8 = 32 In this case, TE and TR decrease. 0 Q P S D Price ($ / unit) Market Q d (units / week) Market Q S (units / week) Table 6.4 S Consumers total expenditure and producers total revenue: A H

93 Chapter 6 B.Effects on total expenditure and total revenue 93 The effect of a quota on total revenue depends on the elasticity of demand between the original equilibrium price and the new market price: If demand is inelastic (i.e., E d < 1), then total revenue will increase. If demand is elastic (i.e., E d > 1), then total revenue will decrease. If demand is unitarily elastic (i.e., E d = 1), then total revenue will remain unchanged.

94 Chapter 6 C.Effect on quality 94 A producer may need to pay a price to obtain a quota right. Both the prices of higher quality goods and lower quality goods increase by the same amount. How does the price of a higher quality good relative to the price of a lower quality good change? Before the imposition of quota: Relative price of a higher quality good = Price of a higher quality good Price of a lower quality good After the imposition of quota: Relative price of a higher quality good = Price of a higher quality good Price of a lower quality good + Price of quota right The price of a higher quality good relative to the price of a lower quality good will decrease.

95 Chapter 6 C.Effect on quality 95 As the relative price of a higher quality good decreases, relatively more higher quality goods will be consumed. Thus, when an effective quota is imposed, the average quality of the good will improve.

96 Chapter 6 Effects of an effective quota 96 To conclude, an effective quota has the following effects: 1.The quantity transacted decreases. 2.The market price increases. 3.Producers total revenue (or consumers total expenditure) may increase, decrease or remain unchanged. This depends on the elasticity of demand between the original equilibrium price and the new selling price. 4.It leads to an improvement in product quality.

97 Chapter 6 Test yourself 6.10 What effects will there be on the price and quantity transacted of private cars if the Hong Kong Government imposes an effective quota on imported cars? What about its effects on the quality of imported cars in Hong Kong? 97 Answer: improve The price will increase / decrease. The quantity transacted will increase / decrease. The quality will.

98 Chapter 6 Test yourself 6.11 With reference to Learning tips 6.2, explain how the change in demand or supply affects the effectiveness of quota. 98

99 Chapter 6 Test yourself 6.11 (cont) 99 Answer: When there is a decrease in demand or a decrease in supply, the quota will become ineffective if the new equilibrium quantity is lower than the quota imposed. This can be caused by: (a) A decrease in demand PePe 0 Q P D2D2 P1P1 QeQe D1D1 Q1Q1 (b) A decrease in supply P2P2 0 Q P S1S1 D P1P1 Q1Q1 S2S2 Q2Q2 SqSq SqSq

100 Chapter 6 Learning tips 6.4Ineffective quota A quota is ineffective when it is imposed above the equilibrium quantity. 100 No effect on the price, quantity transacted and total revenue PePe 0 Q P S1S1 D S2S2 Total revenue QeQe Price ($ / unit) Market Q d (units / week) Market Q S Under quota (units / week) Fig An ineffective quota Table 6.5 A quota of 16 units per week on Good X

101 Chapter 6 Past exam Q 5.Refer to the following demand and supply schedules of Good X. 101 A.$5,600 B.$6,400 C.$8,000 D.$9,600 (HKCEE 2011, Q13) Unit price ($) Quantity demanded (Units) Quantity supplied (Units) If the government fixes the production quota of Good X at 80 units, the total expenditure of consumers on the good will be ________.

102 Chapter 6 Past exam Q 6.In Country A, there is a quota restriction on an imported good. When the import quota quantity is Q 1, the market price of the good is P 1. Now suppose Country A increases the quota quantity from Q 1 to Q 3 as shown in the diagram below. As a result, the new total sales revenue would be 102 A.P 1 × Q 1 B.P 2 × Q 2 C.P 1 × Q 3 D.P 3 × Q 3 (HKCEE 2006, Q10)

103 Chapter 6 Past exam Q 7.Last year, the government reduced the import quota of fresh chicken into Hong Kong. On the other hand, many Hong Kong citizens have changed their habit of consuming fresh chicken to consuming chilled chicken. Which of the following diagrams illustrates this phenomenon? 103 (HKCEE 2009, Q12)


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