Lecture 4 Impact of govt.

policies

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.

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.

Price Ceiling
Price Ceiling
A legal maximum on the price at which a good can be sold.

Effects of Price Ceilings A price ceiling creates shortages of the product because QD > QS. Example: Price ceiling of some of the essential products during Ramadan. The result of price ceiling is rationing.

A Market with a Price Ceiling

Price of Ice-Cream Cone Equilibrium price

Supply

$3
2 Shortage Price ceiling Demand

75 Quantity supplied

125 Quantity demanded

Quantity of Ice-Cream Cones

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 the holy fasting month of Ramadan not only in Bangladesh but also in many other Muslim countries. Traders do it, taking advantage of the anticipated spike in local demand. Prices start to take vertical drift leaving the common 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 someA businessmen and lack of proper monitoring by the government ahead of the Ramadan. Under these circumstances (like any other year) in 2013 govt. took initiative to control price. Govt. decided to set ceiling prices for some of the essential commodities. For example govt. fixed the retail price of lentils at Tk. 70-80 per kg, chickpeas at Tk. 62 per kg and dates at Tk. 75-80 per kg.

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

A Market with a Price Floor

Price of Ice-Cream Cone Surplus $4 3 Equilibrium price

Supply

Price floor

Demand 0 Quantity of Quantity Quantity Ice-Cream Cones demanded supplied 80 120

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.

How the Minimum Wage Affects the Labor Market

Wage

Labor surplus (unemployment) Minimum wage

Labor Supply

Labor demand
0 Quantity demanded Quantity supplied Quantity of Labor

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.

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.

A Tax on Buyers

Price of Ice-Cream Price Cone buyers pay $3.30 Price 3.00 2.80 without tax Price sellers receive

Supply, S1

Tax ($0.50)

Equilibrium without tax

Equilibrium with tax

A tax on buyers shifts the demand curve downward by the size of the tax ($0.50).

D1 D2

90

100

Quantity of Ice-Cream Cones

A Tax on Sellers
Price of Ice-Cream Price Cone buyers pay $3.30 3.00 Price 2.80 without tax Price sellers receive Demand, D1

Equilibrium with tax Tax ($0.50)

S2

S1

A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50).

Equilibrium without tax

90

100

Quantity of Ice-Cream Cones