Supply curve
Perfectly Inelastic → 0 elasticity (vertical) → quantity supplied is the same
regardless of the price
Perfectly elastic → horizontal → small changes in the price lead to very large changes
in the quantity supplied.
Supply Elasticity +1 → quantity supplied changes proportionately more than the price
Supply Elasticity -1 → quantity supplied moves proportionately less than the price
Control on prices
Price controls are usually enacted when policymakers believe that the market price of a good or service
is unfair to buyers or sellers.
Policymakers use taxes to raise revenue for public purposes and to influence market outcomes
Buyers of any good always want a lower price while sellers want a higher price
L Price floor = price cannot fall below this level,
L
Price ceiling = price is not allowed to rise above this level
Effects of price ceilings
1. The price ceiling is higher than the equilibrium price → the price ceiling is not binding →
doesn't effect on the price or quantity
2. The price ceiling is lower than the equilibrium price → the price ceiling is binding → its
forces the supply and demand curve to reach a new equilibrium → the market price equals the
price ceiling → the quantity demanded exceeds the quantity supplied → shortage
Leads to rationing
When the government imposes a
binding price ceiling on a
competitive market, a shortage
arises, and sellers must ration the
goods among the large number of
buyers
Qs = quantity that producers of
gasoline are willing to sell
Qd = quantity that consumers are
willing to buy
Effects of price floors
1. Equilibrium price is above the floor → no effect
2. Equilibrium price is below the floor → binding → the quantity supplied exceeds the
quantity demanded → surplus
Minimum wage (Workers = supply and
firms = demand)
When minimum wage is above the
equilibrium level, the quantity of labor
supplied exceeds the quantity demanded
= unemployment. & raises the incomes of workers who have jobs, lowers the
The impact of the minimum wage incomes of workers who cannot find jobs.
depends on the skill and experience of
the worker.
Taxes
Earned income tax credit = government program that supplements the incomes of low-wage workers
Government use taxes to raise revenue for public projects
Tax incidence = how the tax is distributed among the various people who make up the economy
Effective price = the amount of money sellers get to keep or buyers get to pay after paying taxes
Buyers and sellers share the burden of the tax → buyers pay more and sellers gain less
Takes discorage market activity
Taxes on sellers → + cost of production → + price on the product → buyers pay more and
sellers gain less
Taxes on buyers → + expensive to buy → people buy less → prices falls → buyers pay more
and sellers gain less
The only difference is who sends the
money to the government.
Elasticity and taxes
Determines the division of the tax burden
tax burden falls more heavily on the
Very inelastic → get most of the burden
side of the market that is less elastic.
Very elastic → doesn't get much burden
size of
a tax on a good causes the size of the market for the good to shrink.
·
Welfare without tax Welfare with tax
Consumer surplus = triangle’s area Price paid by buyers raises P1 → Pb
at the price a+b+c Consumer surplus = area A
Producer surplus = triangle’s area area below the demand curve and
at the price d+e+f above the buyers’ price
Total surplus = consumer + producer Price received by sellers falls P1 → Ps
surplus Producer surplus = area F
area between the
area above the supply curve and
supply and demand
below the sellers’ price
curves up to the
equilibrium quantity Quantity sold falls Q1 → Q2
Government tax revenue = area B + D
Total surplus = area A + B + D + F
consumer surplus + producer
Consumer surplus falls → area - (B + C) surplus + tax revenue
Producer surplus falls → area - (D + E)
Tax revenue rises → area B + D
Total welfare → change consumer surplus + change producer surplus + change tax revenue
Total surplus → area - (C + E)
Deadweight lost = the fall in total surplus that results from taxes → area C + E
I
they prevent buyers and sellers from realizing some of the gains from trade
Determinants of the deadweight loss The elasticities
Supply Demand
Inelastic —deadweight —deadweight
Elastic + deadweight + deadweight
They rarely stay
Deadweight Loss and Tax Revenue as Taxes Vary the same over long
periods of times
