1 supply quantity supplied is the amount of a good that sellers are willing and able to sell. law of...
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1
Supply
• Quantity supplied is the amount of a good that sellers are willing and able to sell.
• Law of supply– The law of supply states that, other things
being equal, the quantity supplied of a good rises when the price of the good rises.
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The supply schedule
• Supply schedule– The supply schedule is a table that shows the
relationship between the price of a good and the quantity supplied.
• Supply curve– The supply curve is a graph of the relationship
between the price of a good and the quantity supplied.
3
Market supply versus individual supply
• Market supply refers to the sum of all individual supplies for all sellers of a particular good or service.
• Graphically, individual supply curves are summed horizontally to obtain the market supply curve.
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Shifts in the supply curve
• Change in supply– A shift in the supply curve, either to the left or
right. – Caused by a change in a determinant other
than price.– A change in the good’s price represents a
movement along the supply curve, whereas a change in one of the other variables shifts the supply curve.
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Shifts in the supply curve
Copyright©2003 Southwestern/Thomson Learning
Price ofice-cream
cone
Quantity ofice-cream cones
0
Increasein supply
Decreasein supply
Supply curve, S3
curve, Supply
S1Supply
curve, S2
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Variables that influence sellers
Variables that affect quantity supplied A change in this variable…
Price Represents a movement along the supply curve
Input prices Shifts the supply curve
Technology Shifts the supply curve
Expectations Shifts the supply curve
Number of sellers Shifts the supply curve
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Elasticity of Supply
• Measures the relationship between change in quantity supplied and a change in price
• 1. When supply is elastic, producers can increase production without a rise in cost or a time delay
• 2. When supply is inelastic, firms find it hard to change their production level in a given time period
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• Percentage change in quantity supplied divided by percentage change in price
Coefficient will be positive because an increase in price is likely to increase the quantity supplied to the market.
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• Suppose the market for broccoli is characterized by the following demand and supply functions:
QD = 2,200 – 15P
and
QS = 10P – 800What are the equilibrium price and quantity exchanged? What are the elasticity of demand and supply? Graph the demand and supply functions.
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Measurement of PES
• Es = % change in quantity supplied / % change in price
• Es > 1: Price elastic supply
• Es < 1: Price inelastic supply
• Es = 1: Unit elastic supply
• Es = 0: Perfectly inelastic supply
• Es = ∞: Perfectly elastic supply
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Determinants of supply elasticity1. Factor substitution possibilities- Can labour or capital inputs be switched easily when there is a
change in demand?• When factor substitution is possible and can be achieved at low cost, supply
will be elastic• When factors are highly specialized, substitution may be harder and thus
supply will be inelastic
2. Ability of sellers to change the amount of the good they produce.– Beach-front land is inelastic.– Books, cars, or manufactured goods are elastic.
3. Time period. – Momentary period (fixed supply)– Short – run (inelastic supply)– Long - run (elastic supply
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Market Equilibrium
What do economists mean by "equilibrium?" Market equilibrium is a condition under which the quantity suppliedis equal to the quantity demanded; when a market is in equilibrium, there is no tendency for change.
• The equilibrium price is the price at which the quantity demanded is equal to the quantity supplied.
• Shortages occur when price is below the equilibrium price; shortages cause the price to rise.
• Surpluses occur when price is above the equilibrium price; surpluses cause the price to fall.
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The demand curve can be expressed mathematically. For example,Qd = 50 - 5P
When the price is £3 the Qd = 50- (5*3) = 50 - 15 = 35 unitsWhen the price increases to £5 the Qd = 50 - (5*5) = 50 - 25 = 25 unitsThe supply curve can also be expressed mathematically. For example,
Qs = 2 + 3P. When the price is £10 the quantity supplied = 2 + (3*10) = 32 units
When price increases to £20 the quantity supplied = 2 + (3*20) = 63
Equilbrium occurs where supply equals demand. This means:50 - 5P = 2 + 3P
Rearranging the equation:50 - 2 = 3P + 5P
48 = 8PP = £6
This means the equilibrium price is £6To find the equilibrium quantity we put the value for the price in either the
supply or demand equation.For example: Qs = 2 + (3*6) = 2 + 18 = 20 units
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• Changes in the Market Equilibrium Changes (shifts) in the market supply and demand result in changes in the market equilibrium.
• Recalling the factors that cause changes (shifts) in the marker supply and demand, consider the following changes:
• An increase in demand A decrease in demand An increase in supply A decrease in supply An increase in demand along with an increase in supply An increase in demand along with a decrease in supply A decrease in demand along with an increase in supply A decrease in demand along with a decrease in supply
Multiple EquilibriaTime element
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Supply, Demand, and Government Policies
• In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities.
• While equilibrium conditions may be efficient, it may be true that not everyone is satisfied.
• One of the roles of economists is to use their theories to assist in the development of policies.
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Government Intervention in Markets: Motivation and Economic Consequences
• Price ceilings to help consumers:
-- rent control (selected urban areas)• Price floors to help producers or households:
-- farm price supports, minimum wage law, mandated “time and one half” wage for overtime hours
• Taxes:
-- to raise revenue
-- to reduce amount sold of goods
-- as “user charge” for consuming a good or service
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How does government market intervention affect markets and how do we evaluate such policies?
What are the economic consequences of market intervention? What are the costs and benefits?
• What is the incidence of a tax? Who pays a tax?What determines the incidence?
• THE BIG ISSUE: Intervention in competitive markets affects how the market system performs, with consequences often affecting buyers, sellers, and multiple markets. Is there a compelling public interest to warrant the intervention?
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CONTROLS ON PRICES
• Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.
• Result in government-created price ceilings and floors.
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Government Policies That Regulate Prices • Price controls
– Price ceiling: a legal maximum on the price of a good or service. Example: rent control.
– Prices cannot rise above a certain level. Below the equilibrium price
– It is an implicit tax on producers and an– implicit subsidy to consume
– Price floor: a legal minimum on the price of a good or service. Example: minimum wage.
– Prices cannot fall below a certain level. Above the equilibrium price
– It is a tax on consumers and a subsidy to– producers.– Price floors transfer consumer surplus to– producers.
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How Price Ceilings Affect Market Outcomes
• Two outcomes are possible when the government imposes a price ceiling:– The price ceiling is not binding if set above
the equilibrium price. – The price ceiling is binding if set below the
equilibrium price, leading to a shortage. – Graph
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Figure 1 A Market with a Price Ceiling(a) A Price Ceiling That Is Not Binding
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Equilibriumquantity
$4 Priceceiling
Equilibriumprice
Demand
Supply
3
100
The market clears at $3 and the price ceiling is ineffective.
Figure 1 A Market with a Price Ceiling
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(b) A Price Ceiling That Is Binding
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Demand
Supply
2 PriceceilingShortage
75
Quantitysupplied
125
Quantitydemanded
Equilibriumprice
$3
Shortages
Rationing
First come first served, sellers choose, lottery method, govt decides.
Black market and grey market
Charging for goods and services that were originally free
Provide less service for the same price
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How Price Floors Affect Market OutcomesNon-binding in a high income suburb. graph
W
LD
S
$7.00
500
Price floor
$5.15
A price floor below the eq’m price is not binding – it has no effect on the market outcome.
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How Price Floors Affect Market Outcomes
W
LD
S
$4
Price floor
$5.15The eq’m wage ($4) is below the floor and therefore illegal.The floor is a binding constraint on the wage, and causes a surplus (i.e., less employment).
400 550
labor surplus
Surpluses: Fair trade
Store breaks the manufacturers policy
Legally:
Provide more service for the same money
Simply absorb the surplus
Change the name of the product
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CASE STUDY: Lines at the Gas Pump
• Economists blame government regulations that limited the price oil companies could charge for gasoline.
• 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?
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The Market for Gasoline with a Price Ceiling
(a) The Price Ceiling on Gasoline Is Not Binding
Quantity ofGasoline
0
Price ofGasoline
1. Initially,the priceceilingis notbinding . . . Price ceiling
Demand
Supply, S1
P1
Q1
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The Market for Gasoline with a Price Ceiling
(b) The Price Ceiling on Gasoline Is Binding
Quantity ofGasoline
0
Price ofGasoline
Demand
S1
S2
Price ceiling
QS
4. . . . resultingin ashortage.
3. . . . the priceceiling becomesbinding . . .
2. . . . but whensupply falls . . .
P2
QD
P1
Q1
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CASE STUDY: 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.”
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Figure 3 Rent Control in the Short Run and in the Long Run
(a) Rent Control in the Short Run(supply and demand are inelastic)
Quantity ofApartments
0
Supply
Controlled rent
RentalPrice of
Apartment
Demand
Shortage
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How Price Floors Affect Market Outcomes
• When the government imposes a price floor, two outcomes are possible.– The price floor is not binding if set below the
equilibrium price.– The price floor is binding if set above the
equilibrium price, leading to a surplus.
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How Price Floors Affect Market Outcomes. graph
• A price floor prevents supply and demand from moving toward the equilibrium price and quantity.
• When the market price hits the floor, it can fall no further, and the market price equals the floor price.
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A Market with a Price Floor(a) A Price Floor That Is Not Binding
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Equilibriumquantity
2
Pricefloor
Equilibriumprice
Demand
Supply
$3
100
The government says that ice-cream cones must sell for at least $2; this legislation is ineffective at the current market price.
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A Market with a Price Floor(b) A Price Floor That Is Binding
Quantity ofIce-Cream
Cones
0
Price ofIce-Cream
Cone
Demand
Supply
$4Pricefloor
80
Quantitydemanded
120
Quantitysupplied
Equilibriumprice
Surplus
3
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Evaluating 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 evaluation of such policies must consider all the consequences and how markets adapt! Economists typically look for a ‘compelling’ public interest to justify intervention in markets.
• Price controls reduce total producer and consumer surpluses.
• Governments institute them because people care more about their own surplus than about total surplus.
• Individuals spend money to lobby governments to institute policies that increase their own surplus
• The problem of price controls worsen from
the short run to the long run. Small effects as supply and demand are more inelastic
• In the long run, supply and demand tend
to be much more elastic than in the short
run. Huge effects as supply and demand are more elastic and so shortages and surpluses are larger
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The Difference Between Taxes andPrice Controls
Price ceilings create shortages and taxes
do not unless people try to evade them.
Taxes leave people free to choose how
much to supply and consume as long as
they pay the tax.
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TAXES
• Governments levy taxes to raise revenue for public projects.
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Taxes
• The government levies taxes on many goods & services. Taxes are a source of revenue, and also used to reduce or discourage consumption of selected goods or services. (e.g. cigarette taxes).
• The tax can be a percentage of the good’s price, or a specific amount for each unit sold. – For simplicity, we analyze per-unit taxes only.
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How Taxes on Buyers (and Sellers) Affect Market Outcomes
• Taxes discourage market activity.
• When a good is taxed, the quantity sold is smaller.
• Buyers and sellers share the tax burden.
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The Incidence (who pays) of a tax
• The government can impose taxes on either the buyer or seller.
• The “statutory incidence” of a tax is the economic agent who is legally responsible to pay the tax.
• The “economic incidence’ of a tax is the final distribution of the tax burden between buyer and seller.
• Tax shifting occurs in most cases, as the burden of a tax is shared between buyer and seller, even though only one pays.
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S1
D1
$10.00
500430
A Tax on BuyersA tax on buyers shifts the D curve down by the amount of the tax.
A tax on buyers shifts the D curve down by the amount of the tax.
P
QD2
$11.00PB =
$9.50PS =
Tax
Effects of a $1.50 per unit tax on buyers
The price buyers pay rises, the price sellers receive falls, eq’m Q falls.
The price buyers pay rises, the price sellers receive falls, eq’m Q falls.
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430
S1
The Incidence of a Tax:how the burden of a tax is shared among market participants
P
Q
D1
$10.00
500
D2
$11.00PB =
$9.50PS =
Tax
Because of the tax, buyers pay $1.00 more,
sellers get $0.50 less.
Because of the tax, buyers pay $1.00 more,
sellers get $0.50 less.
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S1
A Tax on SellersA tax on sellers shifts the S curve up by the amount of the tax.
A tax on sellers shifts the S curve up by the amount of the tax.
P
Q
D1
$10.00
500
S2
430
$11.00PB =
$9.50PS =
Tax
Effects of a $1.50 per unit tax on sellers
The price buyers pay rises, the price sellers receive falls, eq’m Q falls.
The price buyers pay rises, the price sellers receive falls, eq’m Q falls.
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S1
The Outcome Is the Same in Both Cases!
What matters is this:
A tax drives a wedge between the price buyers pay and the price
sellers receive.
P
Q
D1
$10.00
500430
$9.50
$11.00PB =
PS =
Tax
The effects on P and Q, and the tax incidence are the same whether the tax is imposed on buyers or sellers!
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Tax Incidence
• What was the impact of tax? – Taxes discourage
market activity.– When a good is taxed,
the quantity sold is smaller.
– Buyers and sellers share the tax burden.
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Elasticity and Tax Incidence• If buyers’ price elasticity > sellers’ price
elasticity, buyers can more easily leave the market when the tax is imposed, so buyers will bear a smaller share of the burden of the tax than sellers.
• If sellers’ price elasticity > buyers’ price elasticity, the reverse is true.
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How the Burden of a Tax Is Divided
Quantity0
Price
Demand
Supply
Tax
Price sellersreceive
Price buyers pay
(a) Elastic Supply, Inelastic Demand
2. . . . theincidence of thetax falls moreheavily onconsumers . . .
1. When supply is more elasticthan demand . . .
Price without tax
3. . . . than on producers.
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How the Burden of a Tax Is Divided
Quantity0
Price
Demand
Supply
Tax
Price sellersreceive
Price buyers pay
(b) Inelastic Supply, Elastic Demand
3. . . . than onconsumers.
1. When demand is more elasticthan supply . . .
Price without tax
2. . . . theincidence of the tax falls more heavily on producers . . .
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Elasticity and Tax Incidence
So, how is the burden of the tax divided?
The burden of a tax falls more heavily on the side of the market that is less elastic.
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CASE STUDY: Who Pays the Luxury Tax?
• 1990’s: Congress adopted a luxury tax on yachts, private airplanes, furs, expensive cars, etc.
• Goal of the tax: to raise revenue from those who could most easily afford to pay – wealthy consumers.
• But who really pays this tax?
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CASE STUDY: Who Pays the Luxury Tax?
The market for yachtsP
Q
D
S
Tax
Buyers’ share of tax burden
Sellers’ share of tax burden
PB
PS
Demand is price-elastic. Demand is price-elastic.
In the short run, supply is inelastic. In the short run, supply is inelastic.
Hence, companies that build yachts pay most of
the tax.
Hence, companies that build yachts pay most of
the tax.
Who bears the burden of tax:
• Perfectly elastic demand and normal supply• Perfectly inelastic demand and normal
supply• Perfectly elastic supply and normal demand• Perfectly inelastic supply and normal
demand•
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A C T I V E L E A R N I N G 2: A C T I V E L E A R N I N G 2: Effects of a taxEffects of a tax
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40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
Suppose govt imposes a tax on buyers of $30 per room.
Find new Q, PB, PS, and incidence of tax.
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AA CC TT II VV E LE L EE AA RR NN II NN G G 22: : AnswersAnswers
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40
50
60
70
80
90
100
110
120
130
140
50 60 70 80 90 100 110 120 130Q
PS
0
The market for hotel rooms
D
Q = 80PB = $110
PS = $80
Incidencebuyers: $10sellers: $20
Tax
PB =
PS =
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Application/Examples (Price floor)The department of agriculture is interested in analyzing the domestic market for potatoes.
The Ministry’s staff estimate the following linear equation for the demand and supply curves as:
Qd = 1600 – 125P
Qs = 440 + 165P
Quantities are measures in hundreds of tons, prices are measured in Nu per ton.
a. Calculate the price and quantity that will prevail in competitive equilibrium.
b. Calculate the elasticity of supply and demand at the competitive equilibrium price
c. Suppose the Govt. imposes a Nu. 4.50 per ton support price (price floor) and commits to buying any surplus that might arise at that price.
1. What impact will this price floor have on the market?
2. Will the govt be forced to purchase potatoes in order to support the price floor? If so, how much and what will be the cost to the Govt.?
3. How much (if any ) additional potatoes will be produced as a result of the price support. How much (if any) less potatoes will be consumed?
d. Now suppose that a new potato hybrid is developed that increases yields so the quantity supplied increases by 145 hundred tons at each level of the potato price. How will your answers to parts a and c be different?
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Example (taxes)
• Suppose the demand for powder milk in March is given (thousands of kgs) by Qd = 1400 – 400Pd. As long as the price is Ch. 50 per kg, the supply is
Qs = - 100 + 200Ps.
1. If there is no tax on milk powder sales then the price paid by consumers will equal the price received by suppliers. In this case what will be the equilibrium price and quantity sold?
2. What are the elasticities of demand and supply at equilibrium?
3. Now suppose that there is a Ch 60 per kg tax on milk powder sold, so that
Ps = Pd - .60. What will be the new quantity sold. What price will be paid by consumers? What price will be received by producers?
4. It is usually the case that the market participants with the lower elasticities end up bearing more of the cost of a tax. Does this seem to be the case here. Explain.