1. Government in the Market

2. Market Disequilibrium
If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium will exist.
In a competitive market, market forces will push the market back to equilibrium.

3. Disequilibrium When price exceeds the equilibrium price, quantity
supplied is greater than
quantity demanded and a
surplus is created. A B Pa D
Q Q2
Quantity

4. Disequilibrium When price is less than the
equilibrium price, a shortage
is created. C F Pb D
Quantity
Q Q2

5. Disequilibrium Pb D If price is above equilibrium,
market forces will push it
down to equilibrium.
If price is below equilibrium,
up to equilibrium. B Pa Pb C F D
Q Q2
Quantity

6. Disequilibrium to Equilibrium
If price equals Pa, quantity supplied exceeds quantity demanded by the amount AB.
The amount AB is excess inventory that businesses will sell at a lower price.
As price falls, quantity demanded increases
As price falls, quantity supplied decreases.
When quantity demanded equals quantity supplied, equilibrium is reached.

7. Disequilibrium to Equilibrium
If price equals Pb, quantity supplied is less than quantity demanded by the amount CF.
The amount CF represents excess demand for the product, permitting businesses to raise price to take advantage of the good’s popularity.
As price rises, quantity demanded decreases
As price rises, quantity supplied increases.
When quantity demanded equals quantity supplied, equilibrium is reached.

8. Government Policies and the Market
Permanent shortages and surpluses can be created through government policies.
A price ceiling is an attempt to keep prices from rising.
A price floor is an attempt to keep prices from falling.

9. Disequilibrium Price Pa is an example of a price ? S A B Pa C F Pb D
Q Q2
Quantity

10. Price Floors
A price floor is an attempt to keep price from falling to equilibrium. Therefore, it must be set above equilibrium.
Price floors cause surpluses because they send a false market signal.
The artificially high price simultaneously increases quantity supplied and decreases quantity demanded.

11. Disequilibrium Price Pb is an example of a price ? S A B Pa C F Pb D
Q Q2
Quantity

12. Price Ceiling
A price ceiling is an attempt to keep price from rising to equilibrium. Therefore, it must be set below equilibrium.
Price ceilings cause shortages because they send a false market signal.
The artificially low price simultaneously decreases quantity supplied and increases quantity demanded.

13. Taxes
Taxes are levied by all levels of government and are a cost of business.
Therefore, we show the effect of a change in taxes by shifting the supply curve
Increases in taxes shift the supply curve to the left.
Decreases in taxes shift the supply curve to the right.

14. Tax Increase At point a, the equilibrium output/
price combination is Q2/P1.
The imposition of a tax shifts the
supply curve from S1 to S2.
At the new equilibrium, the
output/price combination
is Q1/P2.
Output falls while price rises. S1 b P2 P1 a D
Q1 Q2 Q

15. Tax Increase c The tax equals the distance bc or P1P3.
Tax revenue received equals the area
P1P3bc.
Note that the change in the equilibrium
price associated with the imposition of
the tax, P2P3, is less than the tax.
Why? P S1 b P3 P2 P1 a c D
Q1 Q2 Q

16. Tax Incidence
Taxes are not necessarily borne where they are placed. They can be shifted.
The ability to shift a tax depends on the elasticities of demand and supply.
Taxes are borne where the inelasticity is the greatest.

17. Tax Incidence c In this case, the consumer and the
firm bear approximately equal
amounts of the tax.
Price rises to the consumer by the
amount P2P3. The consumer bears
P2P3be.
Price received by the supplier falls
by the amount P2P1. The firm bears
P2P1ce. P S1 b P3 P2 P1 e a c D
Q1 Q2 Q

18. Tax Increase and Demand ElasticityP
When demand is more elastic than supply, the consumer bears a smaller part of the tax.
His/her share of the tax is the amount cb while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His burden is the amount P1P2cf. S1 P3 P2 P1 b a c f D
Q1 Q2 Q
Elastic Demand

19. Tax Increase and Demand Elasticity
When demand is less elastic than supply, the consumer bears a larger part of the tax.
The consumer’s share of the tax is the amount cb while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His burden is the amount P1P2cf. P S1 b P3 P2 P1 c c a f D
Q2Q3 Q
Inelastic Demand

20. Tax Increase and Supply Elasticity
When supply is more elastic than demand, the consumer bears a
larger part of the tax.
His/her share of the tax is the
amount cb while his/her total
burden is the area P2P3bc.
The supplier’s share is the amount
cf. His burden is the amount P1P2cf. S2 S1 b P3 P2 P1 c a f D
Q1 Q2 Q
Elastic Supply

21. Tax Increase and Supply Elasticity
When supply is less elastic than demand,
the consumer bears a smaller part of the tax.
His/her share of the taxis the amount cb
while his/her total burden is the area P2P3bc.
The supplier’s share is the amount cf. His
total burden is the amount P1P2cf. b P3 P2 a c P1 f D
Q1 Q2 Q
Inelastic Supply

22. Conclusions Taxes are borne where the inelasticity is the greatest.
The amount produced decreases more when demand is more elastic. As a result, total tax revenues decline more when demand is more elastic.
Governments prefer to tax inelastic products such as cigarettes, liquor, gasoline.

23. Conclusions Businesses don’t pay taxes; people do.
Taxes may be shifted forward to the consumer or backward to workers.
Taxes imposed on goods and services where the elasticity of demand is inelastic result in smaller changes in production and, therefore, are more efficient.
There are, however, equity issues.
What are they?

24. Tax Increases and Demand ElasticityP S1 c P3 b
When demand in less elastic, the
imposition of a tax results in a
greater change in price and a
smaller change in quantity demanded. P1 P2 a D D
Q1 Q2Q3 Q