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

Economic Analysis for Business Session VIII: Supply Demand and Government Policies-I. Instructor Sandeep Basnyat 9841892281 Sandeep_basnyat@yahoo.com. Government Policies That Alter the Private Market Outcome. Price controls

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

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  1. Economic Analysis for BusinessSession VIII: Supply Demand and Government Policies-I InstructorSandeep Basnyat 9841892281 Sandeep_basnyat@yahoo.com

  2. 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. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  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. P S Rental price of apts $800 D Q 300 Quantity of apartments RENT CONTROL: The Market for Apartments Eq’m w/o price controls CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  5. P S Price ceiling $1000 $800 D Q 300 How Price Ceilings Affect Market Outcomes A price ceiling above the eq’m price is not binding – it has no effect on the market outcome. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  6. P S Price ceiling $500 shortage D Q 400 250 How Price Ceilings Affect Market Outcomes The eq’m price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constrainton the price, and causes a shortage. $800 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  7. P S Price ceiling $500 shortage D Q How Price Ceilings Affect Market Outcomes In the long run, supply and demand are more price-elastic. So, the shortage is larger. $800 450 150 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

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

  9. Supply, S1 1. Initially, the price ceiling is not Price ceiling binding . . . P1 Demand Q1 The Market for Gasoline with a Price Ceiling (a) The Price Ceiling on Gasoline Is Not Binding Price of Gasoline Quantity of 0 Gasoline

  10. S2 2. . . . but when supply falls . . . S1 P2 Price ceiling 3. . . . the price P1 ceiling becomes 4. . . . binding . . . resulting in a Demand shortage. QS QD Q1 The Market for Gasoline with a Price Ceiling (b) The Price Ceiling on Gasoline Is Binding Price of Gasoline Quantity of 0 Gasoline

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

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

  13. labor surplus W S Price floor $5 $4 D L 400 550 How Price Floors Affect Market Outcomes The eq’m wage ($4) is below the floor and therefore illegal. The floor is a binding constrainton the wage, and causes a surplus (i.e., unemployment). CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  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. unemp-loyment W S Min. wage $5 $4 D L 400 550 The Minimum Wage 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%. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  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. Evaluating the Effects of Price Controls • Prices are the signals that guide the allocation of society’s 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. CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  18. Numerical Problems Consider a market with Demand curve q = 16 − 10p and Supply curve q = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg) • Determine the market equilibrium price and quantity and the total revenue in this market. • 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 = −8 + 20p. (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 = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg) • 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. • 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 = −8 + 20p. (Here q is in millions of kgs and p is in dollars/kg) • 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 = - 8 + 20(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. Surplus = 6 million kgs. W S Price support (floor) $1 $0.8 D L 6 12 (d) Illustration of part c on Price Support Policy Govt. Spending 8 CHAPTER 6 SUPPLY, DEMAND, AND GOVERNMENT POLICIES

  23. Thank you

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