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Economic Analysis for Business Session VIII: Supply Demand and Government Policies-I Instructor Sandeep Basnyat

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Presentation on theme: "Economic Analysis for Business Session VIII: Supply Demand and Government Policies-I Instructor Sandeep Basnyat"— Presentation transcript:

1 Economic Analysis for Business Session VIII: Supply Demand and Government Policies-I Instructor Sandeep Basnyat

2 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 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.

3 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.

4 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES RENT CONTROL: The Market for Apartments Eqm w/o price controls P Q D S Rental price of apts $ Quantity of apartments

5 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES How Price Ceilings Affect Market Outcomes A price ceiling above the eqm price is not binding – it has no effect on the market outcome. P Q D S $ Price ceiling $1000

6 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES How Price Ceilings Affect Market Outcomes The eqm price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constraint on the price, and causes a shortage. P Q D S $800 Price ceiling $ shortage

7 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES How Price Ceilings Affect Market Outcomes In the long run, supply and demand are more price-elastic. So, the shortage is larger. P Q D S $ Price ceiling $ shortage

8 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? CASE STUDY: Lines at the Gas Pump Economists blame government regulations that limited the price oil companies could charge for gasoline.

9 The Market for Gasoline with a Price Ceiling (a) The Price Ceiling on Gasoline Is Not Binding Quantity of Gasoline 0 Price of Gasoline 1. Initially, the price ceiling is not binding... Price ceiling Demand Supply,S1S1 P1P1 Q1Q1

10 The Market for Gasoline with a Price Ceiling (b) The Price Ceiling on Gasoline Is Binding Quantity of Gasoline 0 Price of Gasoline Demand S1S1 S2S2 Price ceiling QSQS resulting in a shortage the price ceiling becomes binding but when supply falls... P2P2 QDQD P1P1 Q1Q1

11 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES PRICE FLOOR (PRICE SUPPORT) : The Market for Unskilled Labor Eqm w/o price controls W L D S Wage paid to unskilled workers $4 500 Quantity of unskilled workers

12 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES How Price Floors Affect Market Outcomes? W L D S $4 500 Price floor $3 A price floor below the eqm price is not binding – it has no effect on the market outcome.

13 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES How Price Floors Affect Market Outcomes W L D S $4 Price floor $5 The eqm wage ($4) is below the floor and therefore illegal. The floor is a binding constraint on the wage, and causes a surplus (i.e., unemployment) labor surplus

14 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.

15 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES 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%. The Minimum Wage W L D S $4 Min. wage $ unemp- loyment

16 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.

17 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES Evaluating the Effects of Price Controls Prices are the signals that guide the allocation of societys 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.

18 Numerical Problems Consider a market with Demand curve q = 16 10p and Supply curve q = p. (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.

19 Solved Problems Consider a market with Demand curve q = 16 10p and Supply curve q = p. (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.

20 Numerical Problems Consider a market with Demand curve q = 16 10p and Supply curve q = p. (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).

21 Numerical Problems Consider a market with Demand curve q = 16 10p and Supply curve q = p. (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 = (1) = 12 million kgs. There will be a surplus of 6 million kgs in the market. Total Government expenditure = 6 x 1 = $6 million.

22 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES (d) Illustration of part c on Price Support Policy W L D S $0.8 Price support (floor) $ Surplus = 6 million kgs. 8 Govt. Spend ing

23 Thank you


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