1. Demand & Supply
Dr. Alok Kumar Pandey
Dr. Alok Pandey

2. Agenda for Discussion Income Elasticity Cross elasticity
Market Demand and Market Supply
Bandwagon Effect
Impact of Tax
Price Elasticity and Tax Incidence
Price Ceilings an Price Floors
Dr. Alok Pandey

3. Cross-Price Elasticity of Demand
Responsiveness of D for one good to changes in P of another good
%∆ in demand for one good divided by %∆ in price of another good
If positive: substitutes
If negative: complements
If zero: unrelated
Dr. Alok Pandey

4. Market Demand and Market Supply
Dr. Alok Pandey

5. Bandwagon Effect
Individual demand is influenced by number of other households consuming a commodity
The greater the number of households consuming a commodity
Key to marketing most toys and clothing is to create a bandwagon effect
Results in market demand curve shifting outward
Dr. Alok Pandey

6. Impact of Tax
How do taxes affect the economic well-being of market participants?
It does not matter whether a tax on a good is levied on buyers or sellers of the good.
The price paid by buyers rises, and the price received by sellers falls.
Dr. Alok Pandey

7. The Effects of a Tax Price Demand Supply Price buyers pay
Price sellers
receive
Quantity
with tax
Size of tax
Price
without tax
Quantity
Quantity
Dr. Alok Pandey
Copyright © South-Western

8. How a Tax Affects Market Participants
A tax places a wedge between the price buyers pay and the price sellers receive.
Because of this tax wedge, the quantity sold falls below the level that would be sold without a tax.
The size of the market for that good shrinks.
Dr. Alok Pandey

9. How a Tax Affects Market Participants
Tax Revenue
T = the size of the tax
Q = the quantity of the good sold
T  Q = the government’s tax revenue
Dr. Alok Pandey

10. Tax Revenue Price Demand Supply Quantity with tax Price buyers pay
Price sellers
receive
Tax
revenue
(T × Q)
Size of tax (T)
Quantity
without tax
Quantity
sold (Q)
Quantity
Dr. Alok Pandey
Copyright © South-Western

11. How a Tax Affects Market Participants
The change in total welfare includes:
The change in consumer surplus,
The change in producer surplus, and
The change in tax revenue.
The losses to buyers and sellers exceed the revenue raised by the government.
This fall in total surplus is called the deadweight loss.
Dr. Alok Pandey

12. Price Elasticity and Tax Incidence
Decrease in S by the amount of tax
Tax incidence
Consumers : high P
Producers: net-of-tax receipt
Dr. Alok Pandey

13. Price Elasticity and Tax Incidence
The more price elastic the D:
The more tax producers pay
The less tax consumers pay
The more elastic the S:
The less tax producers pay
The more tax consumers pay
Dr. Alok Pandey

14. Effects of price elasticity of D on tax incidence
(a) Less elastic demand
(b) More elastic demand
Price
1.15
1.00
0.95
Price
1.05
1.00
0.85
0.20 Tax St St D
0.20 Tax S D’ S
Millions of ounces per day 10 9 10 7
The more elastic the D curve, the more tax is paid by producers
(lower net-of-tax receipt)
Dr. Alok Pandey

15. Effects of price elasticity of S on tax incidence
(a) More elastic supply
(b) Less elastic supply
St”
Price
1.15
1.00
0.95
0.20 Tax
Price
1.05
1.00
0.85
St’ S”
D’’
D’’
0.20 Tax S’
quantity 10 8 10 9
The more elastic the S curve, the more tax is paid by consumers
as a higher price.
Dr. Alok Pandey

16. Price Ceilings
A price ceiling establishes a maximum price that sellers are legally permitted to charge.
Example: rent control
When a price ceiling keeps the price of a good below the market equilibrium, there will be both direct and indirect effects.
(Direct effect) A shortage: the quantity demanded will exceed the quantity supplied. Waiting lines may develop.
(Indirect effects) Quality deterioration and changes in other non-price factors that are favorable to sellers & unfavorable to buyers.
The quantity exchanged will fall and the gains from trade will be less than if the good were allocated by markets.

17. The Impact of a Price Control
Price (rent)
Rental housing market
Consider the rental housing market where the price (rent) P0 would bring the quantity of rental units demanded into balance with the quantity supplied. S
A price ceiling like P1 imposes a price below market equilibrium … P0
causing quantity demanded QD …
to exceed quantity supplied QS …
Price
ceiling P1
resulting in a shortage.
Shortage
Because prices are not allowed to direct the market to equilibrium, non-price elements will become more important in determining where the scarce goods go. D
Quantity of housing units QS QD

18. Effects of Rent Control
Shortages and black markets will develop.
The future supply of housing will decline.
The quality of housing will deteriorate.
Non-price methods of rationing will increase in importance.
Inefficient use of housing will result.

19. Price Floor
A price floor establishes a minimum legal price for the good or service.
Example: minimum wage
When a price floor keeps the price of a good above the market equilibrium, it will lead to both direct and indirect effects.
(Direct effect) A surplus: sellers will want to supply a larger quantity than buyers are willing to purchase.
(Indirect effects) Changes in non-price factors that are favorable to buyers and unfavorable to sellers.
The quantity exchanged will fall and the gains from trade will be less than if the good were allocated by markets.

20. The Impact of a Price FloorS
A price floor like P1 imposes a price above market equilibrium …
Surplus P1
Price
floor
causing quantity supplied Qs …
to exceed quantity demanded QD …
resulting in a surplus. P0
Because prices are not allowed to direct the market to equilibrium, non-price elements of exchange will become more important in determining where scarce goods go. D
Quantity QD QS

21. Minimum Wage: An Example of a Price Floor
When the minimum wage is set above the market equilibrium for low-skill labor, the following will occur:
Direct effect:
Reduces employment of low-skilled labor.
Indirect effects:
Reduction in non-wage component of compensation
Less on-the-job training
May encourage students to drop out of school

22. Employment and the Minimum Wage
Price (wage)
Low-skill labor market
Excess supply S
Consider the market for low-skill labor where a price (wage) of could bring the quantity of labor demanded into balance with the quantity supplied.
7.25
Minimum wage level
5.00
A minimum wage (price floor) of would increase the wages of low-skill labor, but employment will decline from E0 to E1 .
Those who lose their jobs will be pushed into either unemployment or less preferred employment. D
Quantity (employment) E1 E0

23. Case Study: Does the Minimum Wage Help the Poor?
While increasing the minimum wage will increase the wages of low-skill workers, their on-the-job training opportunities, non-wage benefits, working conditions, and employment will decline.
Who earns minimum wage?
Most minimum wage workers are young and / or only working part-time.
Fewer than 20 percent are from families with incomes below the poverty line.