Chapter 5 Extensions of Demand Supply and Elasticity

Chapter 5 Extensions of Demand, Supply, and Elasticity Copyright © 2005 Pearson Education Canada Inc. 1

Learning Objectives 5. 1 Explain the role of markets, intermediaries, and prices in the price system. 5. 2 Compare and contrast price ceiling and price floor policies. 5. 3 Compare and contrast the offer-topurchase and the marketing board price support policies. Copyright © 2005 Pearson Education Canada Inc. 2

Learning Objectives 5. 4 Describe the various types of quantity restrictions that governments can impose on markets. 5. 5 Explain how price elasticity governs the effects that a per-unit excise tax has on tax incidence, resource allocation, and government tax revenue collected. Copyright © 2005 Pearson Education Canada Inc. 3

The Price System (market system) § An economic system that allocates resources based on relative prices determined by supply and demand. § Prices signal what is relatively scarce and relatively abundant. Copyright © 2005 Pearson Education Canada Inc. 4

The Price System Transaction Costs § The costs associated with exchange. § Examples • • • Price shopping Determining quality Determining reliability Service availability Cost of contracting Copyright © 2005 Pearson Education Canada Inc. 5

The Price System The Rationing Function of Prices When surpluses and shortages exist price adjusts to clear the market. This adjustment is the rationing function of price. Copyright © 2005 Pearson Education Canada Inc. 6

The Price System When prices cannot adjust non-price rationing occurs § § Rationing by queues Rationing by lotteries Rationing by coupons Rationing by waiting Copyright © 2005 Pearson Education Canada Inc. 7

Price Ceilings and Price Floors Price Controls § Government-mandated minimum or maximum prices. Price Ceiling § A legal maximum price. Price Floor § A legal minimum price. Copyright © 2005 Pearson Education Canada Inc. 8

Price Ceilings and Price Floors Price Ceilings: The Case of Rent Controls Price ceiling and black markets § Price ceilings may prevent the equilibrium price from being achieved if it is above the ceiling price. Copyright © 2005 Pearson Education Canada Inc. 9

Price Ceilings and Price Floors Monthly Rent per Unit S Black market $1000 Price Ceilings: The Case of Rent Controls Pe=$800 Price Ceiling $650 Shortage QS 50, 000 Qe 60, 000 D QD 70, 000 Quantity: Number of units per month Copyright © 2005 Pearson Education Canada Inc. 10

Price Ceilings and Price Floors Non-Price Rationing Devices § All methods used to ration scarce goods that are price-controlled. Black Market § A market in which price-controlled goods are sold at an illegally high price. Copyright © 2005 Pearson Education Canada Inc. 11

Price Ceilings and Price Floors The functions of equilibrium rental prices § Promotes the efficient maintenance and construction of housing § Allocates existing housing § Rations the use of housing Copyright © 2005 Pearson Education Canada Inc. 12

Price Ceilings and Price Floors Discourages the construction of new housing Effects on the existing supply of housing § Property owners cannot recover costs Rationing the current use of housing § Reduces mobility Copyright © 2005 Pearson Education Canada Inc. 13

Price Ceilings and Price Floors Attempts at evading rent controls § Forcing tenants to leave § Tenants subletting apartments § Housing courts Copyright © 2005 Pearson Education Canada Inc. 14

Price Ceilings and Price Floors Who gains and who loses from rent controls? § Losers • Property owners • Low-income individuals § Benefits • Upper-income professionals Copyright © 2005 Pearson Education Canada Inc. 15

Price Ceilings and Price Floors Wage Rate per Unit 800 Unemployed A B C S Wm We Reduction in quantity of labour demanded Excess quantity supplied at wage Wm E Qd Qe Qs 2000 2500 2800 D Increase in quantity of labour supplied Quantity of Labour per Time Period Copyright © 2005 Pearson Education Canada Inc. 16

Price Supports: Offer to Purchase and Marketing Boards Price Supports: The Case of Agriculture • Governments have implemented a variety of price support policies to combat lagging and variable farm income. Copyright © 2005 Pearson Education Canada Inc. 17

Price Supports: Offer to Purchase and Marketing Boards Offer to Purchase policy § § A price floor policy reinforced by the purchase of surplus output by the government. Consumers pay higher prices for the product, and taxpayers purchase excess surplus. Copyright © 2005 Pearson Education Canada Inc. 18

Price Supports: Offer to Purchase and Marketing Boards Price per tonne surplus S Price floor = $700 A surplus of 3000 tonnes per year will result in order to keep the price at $700 Pe= $500 D 14 15 17 Thousands of tonnes Copyright © 2005 Pearson Education Canada Inc. 19

Price Supports: Offer to Purchase and Marketing Boards § A policy which allows producers to band together to restrict total quantity supplied by using quotas. Copyright © 2005 Pearson Education Canada Inc. 20

Price Supports: Offer to Purchase and Marketing Boards Price per tonne S Market Board price = $700 Price will rise to $700 with imposition of a quota. Pe= $500 D 14 15 17 Thousands of tonnes Copyright © 2005 Pearson Education Canada Inc. 21

Price Supports: Offer to Purchase and Marketing Boards Who loses? § Consumers pay more for the product. § New producers must pay for purchasing the quotas. § Foreign producers cannot export to Canada. Copyright © 2005 Pearson Education Canada Inc. 22

Quantity Restrictions Governments may also impose quantity restrictions on a product § Outright ban of a product § Government licensing requirements § Import quotas Copyright © 2005 Pearson Education Canada Inc. 23

Elasticity and Excise Taxes Excise Tax § A tax imposed on a particular commodity or service. • E. g. gasoline, alcohol, cigarettes, hotel rooms Tax Incidence § The division of the burden of a tax between the buyer and seller. Copyright © 2005 Pearson Education Canada Inc. 24

Elasticity and Excise Taxes S 2 $70 S 1 $65 $55 Supply will shift up by $15 with an excise tax of $15. Price per carton $50 D 14 15 17 Thousands of tonnes Copyright © 2005 Pearson Education Canada Inc. 25

Elasticity and Excise Taxes Elasticity and Tax Incidence § When demand is elastic, sellers will bear a greater portion of the tax burden. § When supply is inelastic, buyers will bear a greater portion of the tax burden. Copyright © 2005 Pearson Education Canada Inc. 26