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Lecture 4

Impact of govt. policies

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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.

Price control is an important policy of govt.

which can significantly affect the peoples

welfare.

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CONTROLS ON PRICES

Price control is usually enacted when

policymakers believe the market price is unfair

to buyers or sellers.

There are two types of price control:

1) Price ceilings

2) Price floors.

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Price Ceiling

Price Ceiling

A legal maximum on the price at which a good canbe sold.

Effects of Price CeilingsA price ceiling creates shortages of the productbecause QD > QS.

Example: Price ceiling of some of the essentialproducts during Ramadan. The result of priceceiling is rationing.

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A Market with a Price Ceiling

Quantity ofIce-Cream

Cones0

Price ofIce-Cream

Cone

Demand

Supply

2 PriceceilingShortage

75Quantitysupplied

125Quantity

demanded

Equilibriumprice

$3

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Why prices of essentials go on rising during

Ramadan and how govt. control price

Every year, wholesale and retail prices of essentials shoot up during theholy fasting month of Ramadan not only in Bangladesh but also in manyother Muslim countries. Traders do it, taking advantage of the anticipatedspike in local demand. Prices start to take vertical drift leaving thecommon and especially marginal people beyond their purchasing capacity.Initiatives are taken each and every year; however, we lose the battle in

containing soaring prices due to excessive profit motives of someAbusinessmen and lack of proper monitoring by the government ahead ofthe Ramadan.

Under these circumstances (like any other year) in 2013 govt. tookinitiative to control price. Govt. decided to set ceiling prices for some ofthe essential commodities. For example govt. fixed the retail price oflentils at Tk. 70-80 per kg, chickpeas at Tk. 62 per kg and dates at Tk. 75-80per kg.

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Price Floor

Price Floor

A legal minimum on the price at which a good can

be sold.

The price floor is a price which is set above the

equilibrium price, leading to a surplus of the

product as QS > QD.

Examples: The minimum wage, agricultural

price supports

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A Market with a Price Floor

Quantity ofIce-Cream

Cones0

Price ofIce-Cream

Cone

Demand

Supply

$4 Pricefloor

80Quantity

demanded120

Quantitysupplied

Equilibriumprice

Surplus

3

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Example of Price Floor: Minimum Wage Law

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.

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How the Minimum Wage Affects the Labor Market

Quantity of

Labor

Wage

0

LaborSupplyLabor surplus

(unemployment)

Labordemand

Minimumwage

Quantitydemanded Quantitysupplied

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TAXES

Governments levy taxes to raise revenue for

public projects.

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

Tax incidence is the manner in which the

burden of a tax is shared among participants

in a market.

Tax incidence is the study of who bears the

burden of a tax.

Taxes result in a change in market equilibrium.

Buyers pay more and sellers receive less,

regardless of whom the tax is levied on.

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A Tax on Buyers

Quantity ofIce-Cream Cones0

Price ofIce-Cream

Cone

Pricewithout

tax

Pricesellersreceive

Equilibrium without taxTax ($0.50)

Pricebuyers

pay

D1D2

Supply, S1

A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).

$3.30

90

Equilibriumwith tax

2.803.00

100

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A Tax on Sellers

2.80

Quantity ofIce-Cream Cones

0

Price ofIce-CreamCone

Pricewithout

tax

Pricesellersreceive

Equilibriumwith tax

Equilibrium without taxTax ($0.50)

Pricebuyers

payS1S2

Demand, D1

A tax on sellersshifts the supplycurve upwardby the amount ofthe tax ($0.50).

3.00

100

$3.30

90