Demand supply and economic policy
Download
1 / 49

Demand, Supply and Economic Policy - PowerPoint PPT Presentation


  • 227 Views
  • Uploaded on

Demand, Supply and Economic Policy. Lecture 4 – academic year 2013/14 Introduction to Economics Fabio Landini. Where we are…. Lecture 1: demand and supply Lecture 2: the concept of elasticity Lecture 2: elasticity of demand (high and low) and total revenue

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' Demand, Supply and Economic Policy' - carter


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Demand supply and economic policy

Demand, Supply and Economic Policy

Lecture 4 – academic year 2013/14

Introduction to Economics

Fabio Landini


Where we are
Where we are…

  • Lecture 1: demand and supply

  • Lecture 2: the concept of elasticity

  • Lecture 2: elasticity of demand (high and low) and total revenue

  • Lecture 3: demand, supply and elasticity – exercises and applications


What do we do today
What do we do today?

  • Economic policy: what is it and how it works?

  • Price regulation

  • Taxes and their effects


Question of the day
Question of the day

Since 2007, in Italy there exist an institution called Price Overseeing Authority.

  • What does it do?

    • Overseeing: it verifies the prices

    • Coordination: it functions as a bridge between producers and consumers

      QUESTION: Why do we need it?


Demand supply and economic policy1
Demand, supply and economic policy

Government can affect market’s functioning in two ways:

  • By regulating economic activities (p & q max and min);

  • By imposing taxes and subsidies.


Price regulation and market equilibrium
Price regulation and market equilibrium

In a market with no regulation, market forces establish the equilibrium level of p and q.

Even if the market is in equilibrium, somebody can be unsatisfied (for reasons associated with equity or efficiency).


Price regulation and market equilibrium1
Price regulation and market equilibrium


When are prices regulated
When are prices regulated?

When politicians believe p of a given market to be unequal.

In these cases max or min level of prices is fixed.

Usually, there are efficiency costs (this is the classic trade-off between efficiency and equity!)


Max and min level of price
Max and min level of price

Max (min) level

  • It is max (min) price that a good can be sold at according to law.


Max level of price
Max level of price

When the government imposes a max level of price, there are two possible consequences:

  • p max is NOT CONSTRAINING: if the market price is < than p max.

  • p max is CONSTRAINING:if the market price is > than p max. In this case artificial scarcityis created…


Max price is not constraining
Max price is NOT CONSTRAINING

Price of

ice-cream

Supply

Max Price

4

3

Equilibrium price

Demand

0

100

Quantity of

Ice-cream

Equilibrium quantity


Max price is constraining
Max price is CONSTRAINING

Price of

ice-cream

Supply

3

Equilibrium price

2

Max Price

Demand

0

100

Quantity of

Ice-cream

Equilibrium quantity


Max price is constraining1
Max price is CONSTRAINING

Price of

ice-cream

Supply

3

Equilibrium price

2

Max Price

Scarcity

Demand

75

125

0

Quantity of

Ice-cream

Quantity Supplied

Quantity Demanded


The effects of max p
The effects of max p

When it is constraining, a max p …

. . . Generate scarcity QD > QS

Example: Scarcity of petrol in 1970.

. . . Rationing of the good.

Example: long queues,

or: seller’s discrimination practices.


Min level of prices
Min level of prices

Two possible consequences:

  • p min is NOT CONSTRAINING: if p min < than equilibrium price.

  • p min IS CONSTRAINING: if p min > than equilibrium price. In this case excess supply is generated.


Min price is not constraining
Min price is NOT CONSTRAINING

Price of

ice-cream

Supply

3

Equilibrium price

2

Min Price

Demand

0

100

Quantity of

Ice-cream

Equilibrium quantity


Max price is constraining2
Max price is CONSTRAINING

Price of

ice-cream

Supply

4

Min Price

3

Equilibrium price

Demand

0

100

Quantity of

Ice-cream

Equilibrium quantity


Max price is not constraining1
Max price is NOT CONSTRAINING

Price of

ice-cream

Excess

Supply

Supply

Min Price

4

3

Equilibrium price

Demand

75

125

0

Quantity of

Ice-cream

Quantity Demanded

Quantity Supplied


Effects of a min p
Effects of a min p

When constraining, min p min generates . . .

. . . An excess of supply QS > QD

. . . The resources in excess are wasted

Example: Minimum wage; Subsidies to sustain the price of agricultural goods.


(a) Max rent in the short period

(Supply and demand are inelastic)

(b) Max rent in the long period

(Supply and demand are elastic)

Rent

Rent

Supply

Supply

Max rent

Max rent

Scarcity

Demand

Scarcity

Demand

Quantity of flats

0

0

Quantity of flats


(b) Labour market with min wage

(a) Free labour market

Wage

Wage

Excess supply

of labour

Labour supply

Labour supply

(unemployment)

Min wage

Equilibrium wage

Labour demand

Labour demand

Quantity of

0

Quantity of

0

Quantity

Quantity

Equilibrium

employment

employed

employed

demanded

supplied


Taxes effects
Taxes: Effects

Government uses taxation to finance public expenditure.

But taxes are not neutral in that they can discourage market activities.

When a good is taxed, the quantity that is sold diminishes.

In the majority of the cases, buyers and sellers share the tax burden.


Legal incidence and economics of taxes
Legal incidence and economics of taxes

The law establishes who pays the tax (legal incidence). But not who really bears the tax burden (economic incidence).

Let’s see why….


Legal incidence and economics of taxes1
Legal incidence and economics of taxes

The tax affects the market equilibrium:

  • The price for consumers rises, who therefore reduce the quantity demanded.

  • The portion of the price earned by sellers reduces, and therefore they reduce the quantity supplied.


Legal incidence and economics of taxes2
Legal incidence and economics of taxes

The economic incidence (= how the tax burden is shared between consumers and producers) is independent from the subject who is legally responsible for paying the tax … (that is the legal incidence).

It depends on ED and ES.


The effect of a tax on consumption goods
The effect of a tax on consumption goods

Initial price of an apple: 1€

Then: consumption tax of 0,10€ for each apple. What happens to the price of apples after tax?

Let’s see the cases:

  • The prince remains equal to 1€. In this case, the tax is paid ONLY by the producer: the consumer pays 1€; 0,10€ goes to State and only 0,90€ to the producer;

  • The price rises to 1,10€. Then the tax is paid ONLY by the consumer.


The effect of a tax on consumption goods1
The effect of a tax on consumption goods

In the majority of the cases “the true lies in between”: the tax rises both the price to consumers and the price to producers.

Example: the price to consumers can become 1,05 and the price to producers 0,95.

The final price depends on the elasticity of demand and supply.


The effect of a tax on consumption goods2
The effect of a tax on consumption goods

Hp.: producers respond to price four times more than consumers (i.e.: ES(p)=4xED(p)).

To maintain the market equilibrium the price to consumers must rise to 1,08 and the one to producers must fall to 0,98.

In this way, the price to consumers (+8%) is four times than the price to producers (-2%), and thus: quantity demanded = quantity supplied.


The effect of a tax on consumption goods3
The effect of a tax on consumption goods

Price of

ice-cream

Supply

3,00

Equilibrium without the tax

Demand

Quantity of

0

100

Ice-cream


The effect of a tax on consumption goods4
The effect of a tax on consumption goods

Price of

ice-cream

A tax on consumption shifts the demand curve leftward

Supply

3,00

Equilibrium without the tax

Demand

Quantity of

0

100

Ice-cream


The effect of a tax on consumption goods5
The effect of a tax on consumption goods

Price of

ice-cream

A tax on consumption shifts the demand curve leftward

Supply

3,00

Equilibrium without the tax

New equilibrium with the tax

Demand

Quantity of

0

100

Ice-cream


The effect of a tax on consumption goods6
The effect of a tax on consumption goods

Price of

ice-cream

Supply

pD

Tax (t)

Equilibrium without the tax

pS

New equilibrium with the tax

Demand

Quantity of

0

Qt

Ice-cream



The effect of a tax on consumption goods8
The effect of a tax on consumption goods

Price of

ice-cream

Supply

3,00

Equilibrium without the tax

Demand

Quantity of

0

100

Ice-cream


The effect of a tax on consumption goods9
The effect of a tax on consumption goods

Price of

ice-cream

A tax on production (0,50 cents) shifts the supply curve leftward.

Supply

3,00

Equilibrium without the tax

Demand

Quantity of

0

100

Ice-cream


The effect of a tax on consumption goods10
The effect of a tax on consumption goods

New equilibrium with the tax

Price of

ice-cream

A tax on production (0,50 cents) shifts the supply curve leftward.

Supply

3,00

Equilibrium without the tax

Demand

Quantity of

0

100

Ice-cream


The effect of a tax on consumption goods11
The effect of a tax on consumption goods

New equilibrium with the tax

Price of

ice-cream

A tax on production (0,50 cents) shifts the supply curve leftward.

Supply

3,30

Tax (0,50)

Equilibrium without the tax

2,80

Demand

Quantity of

0

80

Ice-cream


Incidence of taxes
Incidence of taxes

How is the tax burden shared between consumers and producers?

All depends on the elasticity of the demand and supply curves.

The tax burden mainly falls on the less elastic market component.


Elasticity and incidence of taxes
Elasticity and incidence of taxes

If the demand is inelastic and the supply is elastic: The tax is paid mainly by the consumer.

If the demand is elastic and the supply is inelastic: The tax is paid mainly by the producer.


Elastic supply inelastic demand
Elastic supply + inelastic demand

Price

Supply

Price before tax

Demand

0

Quantity


Elastic supply inelastic demand1
Elastic supply + inelastic demand

Price

Price to consumer

Supply

Tax burden

Price before tax

Price to producer

Demand

0

Quantity


Elastic supply inelastic demand2
Elastic supply + inelastic demand

Price

1. If the supply is more elastic then the demand...

Price to consumer

Supply

Tax burden

2. …the tax affects more the consumer...

Price before tax

Price to producer

Demand

3. …then the producer.

0

Quantity


Inelastic supply elastic demand
Inelastic supply + elastic demand

Price

Supply

Price before tax

Demand

0

Quantity


Inelastic supply elastic demand1
Inelastic supply + elastic demand

Price

Supply

Price to consumer

Price before tax

Tax burden

Price to producer

Demand

0

Quantity


Inelastic supply elastic demand2
Inelastic supply + elastic demand

1. If the demand is more elastic than the supply..

Price

Supply

Price to consumer

3. …Than on the consumer.

Price before tax

Tax burden

Price to producer

Demand

2. …the tax impacts more on the producer...

0

Quantity


Conclusion
Conclusion

The economy is ruled by two kinds of law:

  • The law of demand and supply

  • The laws enacted by the legislator


Conclusion1
Conclusion

Regulated prices include either a minimum or a maximum (or both) level of price.


Conclusion2
Conclusion

Taxes on production and consumption create new equilibrium prices, where consumers and producers share in the tax burden.

The incidence of the tax depends on the elasticity of demand and supply.


Next lecture
Next lecture

Market efficiency…


ad