government in the market. market disequilibrium if quantity demand exceeds quantity supplied or...

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Government in the Market

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Page 1: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Government in the Market

Page 2: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 3: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

DisequilibriumPrice

QuantityD

S

A B Pa

Q1 Q2

When price exceeds theequilibrium price, quantitysupplied is greater thanquantity demanded and asurplus is created.

0

Page 4: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

DisequilibriumPrice

QuantityD

S

C F

Pb

Q1 Q2

When price is less than theequilibrium price, a shortageis created.

0

Page 5: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

DisequilibriumPrice

QuantityD

S

A B

C F

Pa

Pb

Q1 Q2

If price is above equilibrium,market forces will push itdown to equilibrium.

If price is below equilibrium,market forces will push itup to equilibrium.

0

Page 6: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 7: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 8: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 9: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

DisequilibriumPrice

QuantityD

S

A B

C F

Pa

Pb

Q1 Q2

Pa is an example of a price ?

0

Page 10: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 11: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

DisequilibriumPrice

QuantityD

S

A B

C F

Pa

Pb

Q1 Q2

Pb is an example of a price ?

0

Page 12: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 13: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 14: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increase

0 Q

D

S1

S2

P

Q1 Q2

P2

P1a

b

At point a, the equilibrium output/price combination is Q2/P1.

The imposition of a tax shifts thesupply curve from S1 to S2.

At the new equilibrium, theoutput/price combinationis Q1/P2.

Output falls while price rises.

Page 15: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increase

0 Q

D

S1

S2

P

Q1 Q2

P3

P2

P1

a

b

c

The tax equals the distance bc or P1P3.

Tax revenue received equals the areaP1P3bc.

Note that the change in the equilibrium price associated with the imposition of the tax, P2P3, is less than the tax.

Why?

Page 16: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 17: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Incidence

0 Q

D

S1

S2

P

Q1 Q2

P3

P2

P1

a

b

c

In this case, the consumer and thefirm bear approximately equal amounts of the tax.

Price rises to the consumer by theamount P2P3. The consumer bearsP2P3be.

Price received by the supplier fallsby the amount P2P1. The firm bearsP2P1ce.

e

Page 18: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increase and Demand Elasticity

0 Q

D

S1

S2P

Q1 Q2

P3

P2

P1

ab

Elastic Demand

c

f

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.

Page 19: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increase and Demand Elasticity

0 Q

S1

S2

P

Q2Q3

P2

P1

a

b

D

P3

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.

c

f

c

Inelastic Demand

Page 20: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increase and Supply Elasticity

0 Q

D

S1

S2

P

Q1 Q2

P3

P2

P1

a

b

c

f

Elastic Supply

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.

Page 21: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increase and Supply Elasticity

0 Q

D

S1S2P

Q1 Q2

P3

P2a

b

P1

c

f

Inelastic Supply

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.

Page 22: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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.

Page 23: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

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?

Page 24: Government in the Market. Market Disequilibrium If quantity demand exceeds quantity supplied or quantity supplied exceeds quantity demanded, a disequilibrium

Tax Increases and Demand Elasticity

0 Q

D

S1

S2P

Q1 Q2Q3

P1

P2a

b

D

P3 When demand in less elastic, theimposition of a tax results in agreater change in price and asmaller change in quantity demanded.

c