ECON 101 Lecture 5 - Supply Demand and Government Policies-1

ECON 101: INTRODUCTION TO
ECONOMICS I
Lecture 5 – Supply, Demand, and

Government Policies
Dr. Emmanuel Adu-Danso (Group A)
Department of Economics
School of Social Studies
2022/2023
Lecture Overview
• In this lecture, we introduce the visible hand
(government) into our market analysis and see how it
affects the market.
• We start with the concepts of price ceilings and price
floors and how they affect market outcomes
• We will also introduce government taxes and their
observed effect on market outcomes.
• We end with a discussion on the incidence of taxes
• This lecture will be based on Mankiw, G. (2012).
Principles of Economics (6th Edition), South Western.
– Chapter 6
Dr. Emmanuel Adu-Danso, Economics Department Slide 2
Government Policies That Alter the
Private Market Outcome
• Price controls
– Price ceiling: a legal maximum on the price
of a good or service Example: rent control
– Price floor: a legal minimum on the price of
a good or service Example: minimum wage
• Taxes
– The govt can make buyers or sellers pay a specific
amount on each unit.
We will use the supply/demand model to see
how each policy affects the market outcome
(the price buyers pay, the price sellers receive, and eq’m
quantity).
EXAMPLE 1: The Market for Apartments
Rental P S
price of
apts
¢800
Eq’m w/o
price controls
D
Q
300
Quantity of apts
How Price Ceilings Affect Market Outcomes
A price ceiling P
above the S
Price
eq’m price is ¢1000
ceiling
not binding—
has no effect ¢800
on the market
outcome.
D
Q
300

The eq’m price P S

(¢800) is above
the ceiling and
therefore illegal.
The ceiling ¢800
is a binding Price
constraint ¢500
ceiling
on the price, shortage
causes a D
shortage. Q
250 400

In the long run, P S

supply and
demand
are more
₵800
price-elastic.
So, the shortage Price
₵500
is larger. ceiling
shortage
D
Q
150 450

Shortages and Rationing
• With a shortage, sellers must ration the goods among

buyers.
• Some rationing mechanisms:

– Long lines
– Discrimination according to sellers’ biases
• These mechanisms are often unfair, and inefficient:

the goods do not necessarily go to the buyers who
value them most highly.
Shortages and Rationing
• In contrast, when prices are not controlled,

the rationing mechanism is
efficient (the goods go to the buyers that value
them most highly)
and impersonal (thus fair).

Effect of a Price Floor
EXAMPLE 2: The Market for Unskilled Labor
Wage W S
paid to
unskilled
workers
¢600
Eq’m w/o
price controls
D
L
500
Quantity of
unskilled workers
How Price Floors Affect Market Outcomes
A price floor W
below the S
eq’m price is
not binding –
has no effect ¢600
on the market
outcome. Price
¢500
floor
D
L
500

How Price Floors Affect Market Outcomes
labor
The eq’m wage (¢600) W surplus S
is below the floor and Price
therefore ¢725
floor
illegal.
The floor ¢600
is a binding constraint
on the wage,
causes a
surplus (i.e., D
L
unemployment). 400 550

The Minimum Wage
• Min wage laws unemployment

W S
do not affect
highly skilled workers. Min.
¢725
wage
• They may affect youth
unemployment.
¢600
• In advanced
economies, studies
show that a 10% rise in
min wage increases
youth/ teen D
unemployment by 1- L
3% 400 550

Evaluating Price Controls
• Recall one of the Ten Principles from Chapter 1:
Markets are usually a good way
to organize economic activity.
• Prices are the signals that guide the allocation of

society’s resources. This allocation is altered when
policymakers restrict prices.
• Price controls often intended to help the poor,

but often hurt more than help:
– Job loses; availability (and quality) of rental apartments
Taxes
• The govt levies taxes on many goods & services to
raise revenue to pay for national defense, public
schools, etc.
• The govt can make buyers or sellers pay the tax.
• The tax can be a % of the good’s price, or a specific

amount for each unit sold (per unit tax).
– For simplicity, we analyze per-unit taxes only.
EXAMPLE 3: The Market for LPG Gas
Eq’m
w/o tax P
S1
¢100
D1
Q
500
A Tax on Buyers e.g. LPG gas
The priceabuyers
Hence, paybuyers
tax on Effects of a ¢15 per
is now the
shifts ₵15 higher than
D curve the
down unit tax on buyers
market
by the price
amountP. of the tax. P
P would have to fall S1
by ¢15 to make
buyers willing ¢100
Tax
to buy same Q
as before.
¢85
E.g., if P falls D1
from ¢100 to ¢85, D2
then buyers will be willing to Q
500
purchase 500 units of LPG gas.
A Tax on Buyers
New eq’m: Effects of a ¢15 per
unit tax on buyers
Q = 450 P
Sellers S1
receive PB = ¢110
Tax
PS = ¢95 ₵100
Buyers pay PS = ¢95
PB = ¢110
D1
Difference
between them D2
= ¢15 = tax Q
450 500
The Incidence of a Tax:
how the burden of a tax is shared among

market participants (buyers and sellers)
P
In our
S1
example, PB = ¢110
Tax
buyers pay ¢100
¢10 more, PS = ¢95
sellers get
¢5 less. D1
D2
Q
Dr. Emmanuel Adu-Danso, Economics Department
450 500
Slide 19
A Tax on Sellers
The tax effectively raises Effects of a ¢15 per
sellers’ costs by unit tax on sellers
P S2
¢15 per liter. ¢115
Tax S1
Sellers will supply
500 liters
¢100
only if
P rises to ¢115,
to compensate for
this cost increase. D1
Hence, a tax on sellers shifts the Q

S curve up by the amount of the tax. 500
A Tax on Sellers
New eq’m: Effects of a ¢15 per
unit tax on sellers
Q = 450 P S2
Buyers pay S1
PB = ¢110 PB = ¢110
Tax
Sellers ¢ 100
receive PS = ¢95
PS = ¢95
D1
Difference
between them Q
= ¢15 = tax 450 500
The Outcome Is the Same in Both Cases!
The effects on P and Q, and the tax incidence are the
same whether the tax is imposed on buyers or sellers!
What matters P
is this: S1
PB = ¢110
A tax drives Tax
a wedge ¢100
between the PS = ¢95
price buyers
pay and the D1
price sellers
receive. Q
Dr. Emmanuel Adu-Danso, Economics Department
450 500
Slide 22
Elasticity and Tax Incidence
CASE 1: Supply is more elastic than demand
P
It’s easier
for sellers
PB S
than buyers
Buyers’ share
to leave the
of tax burden
Tax market.
Price if no tax So buyers
Sellers’ share
bear most of
PS
of tax burden the burden
of the tax.
D
Q
Elasticity and Tax Incidence
CASE 2: Demand is more elastic than supply
It’s easier
P
S for buyers
Buyers’ share than sellers
of tax burden PB to leave the
market.
Price if no tax
Tax Sellers bear
Sellers’ share most of the
of tax burden PS burden of
D the tax.
Q
CONCLUSION: Government Policies and the Allocation
of Resources
• Each of the policies looked at affects the allocation of
society’s resources.
– Example 1: A tax on LPG gas reduces eq’m Q.
With less production of LPG gas, resources (workers,
plants, trucks) will become available to other industries.
– Example 2: A binding minimum wage causes
a surplus of workers, a waste of resources.
• So, it’s important for policymakers to apply such

policies very carefully.
Summary
• A price ceiling is a legal maximum on the price of a
good. An example is rent control. If the price ceiling
is below the eq’m price, it is binding and causes a
shortage.
• A price floor is a legal minimum on the price of a
good. An example is the minimum wage. If the price
floor is above the eq’m price, it is binding
and causes a surplus. The labor surplus caused by
the minimum wage is unemployment.

Summary
• A tax on a good places a wedge between the price
buyers pay and the price sellers receive, and causes
the eq’m quantity to fall, whether the tax is imposed
on buyers or sellers.
• The incidence of a tax is the division of the burden of
the tax between buyers and sellers, and does not
depend on whether the tax is imposed on buyers or
sellers.
• The incidence of the tax depends on the price
elasticities of supply and demand.

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ECON 101: INTRODUCTION TO

Lecture 5 – Supply, Demand, and

Dr. Emmanuel Adu-Danso (Group A)

Dr. Emmanuel Adu-Danso, Economics Department Slide 5

The eq’m price P S

Dr. Emmanuel Adu-Danso, Economics Department Slide 6

In the long run, P S

Dr. Emmanuel Adu-Danso, Economics Department Slide 7

• With a shortage, sellers must ration the goods among

• Some rationing mechanisms:

• These mechanisms are often unfair, and inefficient:

• In contrast, when prices are not controlled,

Dr. Emmanuel Adu-Danso, Economics Department Slide 9

Dr. Emmanuel Adu-Danso, Economics Department Slide 11

Dr. Emmanuel Adu-Danso, Economics Department Slide 12

• Min wage laws unemployment

Dr. Emmanuel Adu-Danso, Economics Department Slide 13

• Prices are the signals that guide the allocation of

• Price controls often intended to help the poor,

• The govt can make buyers or sellers pay the tax.

• The tax can be a % of the good’s price, or a specific

how the burden of a tax is shared among

Hence, a tax on sellers shifts the Q

• So, it’s important for policymakers to apply such

Dr. Emmanuel Adu-Danso, Economics Department Slide 26

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