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Objectives and Homework

Review elasticity
Identify price controls
Define Deadweight Loss
Graphically analyze effects of government interventions
Problem Set 2 #6abc
Problem Set due tomorrow
P 622

1

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Unit 2: Supply, Demand, and Consumer Choice

2

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Elasticity

Is the following demand curve elastic, inelastic, or unit elastic?

3

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Elasticity

Is the following demand curve elastic, inelastic, or unit elastic?

4

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Government Involvement

5

#1-Price Controls: Floors and Ceilings�#2-Import Quotas�#3-Subsidies�#4-Excise Taxes�

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6

#1-PRICE CONTROLS

Who likes the idea of having a price ceiling on gas so prices will never go over $2 per gallon?

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Q

o

$5

4

3

2

1

P

10 20 30 40 50 60 70 80

7

D

S

Shortage

(Qd>Qs)

Maximum legal price a seller can charge for a product.

Goal: Make affordable by keeping price from reaching Eq.

Gasoline

Does this policy help consumers?

Result: BLACK MARKETS

Price Ceiling

To have an effect,

a price ceiling must be

below equilibrium

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Q

o

$

4

3

2

1

P

10 20 30 40 50 60 70 80

8

D

S

Surplus

(Qd<Qs)

Minimum legal price a seller can sell a product.

Goal: Keep price high by keeping price from falling to Eq.

Corn

Does this policy help corn producers?

Price Floor

To have an effect,

a price floor must be

above equilibrium

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Practice Questions

9

1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium?

Surpluses will develop
Shortages will develop
Underground markets will develop
The equilibrium price will ration the good
The quantity sold will increase

A. A price ceiling causes a shortage if the ceiling price is above the equilibrium price

B. A price floor causes a surplus if the price floor is below the equilibrium price

C. Price ceilings and price floors result in a misallocation of resources

D. Price floors above equilibrium cause a shortage

2. Which of the following statements about price control is true?

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Are Price Controls Good or Bad?

To be “efficient” a market must maximize consumers and producers surplus

Q

P

D

S

P_c

Q_e

CS

PS

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Price FLOOR

Q

P

D

S

P_c

Q_e

Q_floor

DEADWEIGHT LOSS The Lost CS and PS.

INEFFICIENT!

CS

PS

Are Price Controls Good or Bad?

To be “efficient” a market must maximize consumers and producers surplus

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Are Price Controls Good or Bad?

To be “efficient” a market must maximize consumers and producers surplus

Q

P

D

S

P_c

Q_e

CS

PS

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13

Price CEILING

Q

P

D

S

P_c

Q_e

Q_ceiling

DEADWEIGHT LOSS The Lost CS and PS.

INEFFICIENT!

CS

PS

Are Price Controls Good or Bad?

To be “efficient” a market must maximize consumers and producers surplus

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Objectives and Homework

Graphically analyze effects of government interventions such as quotas and excise taxes
Complete Excise Tax Worksheet
Problem Set 2 #5b (look over #4b as well)
Problem Set due Wednesday

14

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Practice Questions

15

1. Which of the following will occur if a legal price floor is placed on a good below its free market equilibrium?

Surpluses will develop
Shortages will develop
Underground markets will develop
The equilibrium price will ration the good
The quantity sold will increase

A. A price ceiling causes a shortage if the ceiling price is above the equilibrium price

B. A price floor causes a surplus if the price floor is below the equilibrium price

C. Price ceilings and price floors result in a misallocation of resources

D. Price floors above equilibrium cause a shortage

2. Which of the following statements about price control is true?

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#2 Import Quotas

16

A quota is a limit on the number of imports.

(The government sets the maximum amount that can come into the country)

Purpose:

To protect domestic producers from a cheaper world price.
To prevent domestic unemployment
pp 741-743

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International Trade and Quotas

Identify the following:

CS with no trade
PS with no trade
CS if we trade at world price (P_W)
PS if we trade at world price (P_W)
Amount we import at world price (P_W)
If the government sets a quota on imports of Q₁– Q_4,(raising price to P_T) what happens to CS and PS?

This graphs show the domestic supply and demand for grain. The letters represent area.

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#3 Subsidies

18

The government just gives producers money.

The goal is for them to make more of the goods that the government thinks are important.

Ex:

Agriculture (to prevent famine)
Pharmaceutical Companies
Environmentally Safe Vehicles
FAFSA

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Result of Subsidies to Corn Producers

Q

o

Price of Corn

Quantity of Corn

19

S

S_Subsidy

Price Down

Quantity Up

Everyone Wins, Right?

P_e

P₁

Q_e

Q₁

D

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20

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#4 Excise Taxes

Excise Tax = A per unit tax on producers

For every unit made, the producer must pay $

NOT a Lump Sum (one time only)Tax – PER UNIT

Common Examples:

Cigarettes “sin tax”
Alcohol “sin tax”
Tariffs on imported goods
Environmentally Unsafe Products
Etc. P.622

21

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Excise Taxes

Q

o

$5

4

3

2

1

P

22

Supply Schedule

P	Qs
$5	140
$4	120
$3	100
$2	80
$1	60

D

S

40 60 80 100 120 140

Government sets a $2 per unit tax on Cigarettes

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Q

o

$5

4

3

2

1

P

23

P	Qs
$5 $7	140
$4 $6	120
$3 $5	100
$2 $4	80
$1 $3	60

D

S

40 60 80 100 120 140

Excise Taxes

Supply Schedule

Government sets a $2 per unit tax on Cigarettes

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Q

o

$5

4

3

2

1

P

24

P	Qs
$5 $7	140
$4 $6	120
$3 $5	100
$2 $4	80
$1 $3	60

D

S

40 60 80 100 120 140

Tax is the vertical distance between supply curves

S_Tax

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$160

Excise Taxes

Q

o

$5

4

3

2

1

P

25

D

S

40 60 80 100 120 140

Identify the following:

Price before tax
Price consumers pay after tax
Price producers get after tax
Total tax revenue for the government before tax
Total tax revenue for the government after tax
Dead Weight Loss

S_Tax

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26

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S

P

Q

D

Excise Tax

12

10

$14

12

11

8

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S

P

Q

D

Excise Tax

$14

12

11

8

Calculate

Tax Per Unit
Total Tax Revenue
Amount of Tax paid by consumers
Amount of Tax paid by producers
Total Expenditures
Total Revenue for firms
Is demand relatively elastic or inelastic?

12

10

S_tax

P_c

P_p

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Elasticity and Excise Taxes

Who pays the tax?
Also known as tax incidence or tax burden
Given identical upward sloping supply curves…

If demand is relatively ELASTIC, the PRODUCER pays more of the tax out of their surplus.
If demand is relatively INELASTIC, the CONSUMER pays more of the tax out of their surplus.

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Tax Consumers Pay

Q

0

P

31

D

S

S_Tax

P_e

Q_e

P_c

P_p

Q_t

Tax Producers Pay

Inelastic Demand and Excise Taxes

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Tax Consumers Pay

Q

0

P

32

D

S

S_Tax

P_e

Q_e

P_c

P_p

Q_t

Tax Producers Pay

Elastic Demand and Excise Taxes

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Good X

Good Y

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CS Before Tax
PS Before Tax
CS After Tax
PS After Tax
Tax Revenue for Government
Dead Weight Loss due to tax
Amount of tax revenue producers pay

Tax Practice (actual FRQ graph)

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Worksheet

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Objectives:

36

Review Excise Taxes
Calculate Marginal Utility and Marginal Utility/Price
Define Utility Maximizing Rule

Homework:

Problem Set 2 #6
Completed and TYPED Problem Set 2 due tomorrow
See the website www.MrCromie.net for review exercises
Multiple Choice on Wednesday!
FRQs on Friday!

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Tax Consumers Pay

Inelastic Demand and Excise Taxes

Q

0

P

37

D

S

S_Tax

P_e

Q_e

P_c

P_p

Q_t

Tax Producers Pay

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Result of Quotas

Q

o

Price of Corn

Quantity of Corn

38

S

S_Quota

P_e

P₁

Q_e

Q₁

D

What happens to overall consumer and producer surplus?

Is this allocatively efficient?