Econ 11 Topic 4

APPLICATIONS OF SUPPLY AND DEMAND

PRICE CONTROL: FLOOR PRICE (Pf)

Floor price - is the minimum price policy or the lower limit on a price.
- commonly applied to minimum wages and as price support for agricultural commodities.
- usually set above the equilibrium price and causes a surplus in the market. because Pf will not have an impact
(ineffective) if set below the P*.

Additional Note:
- the equilibrium will not be reached because of the control that is mandated by law.
- floor price is intended for the benefit of the supplier. however, there are repercussions in some cases such as in labor
markets.

- displaced workers = previous workers who lost their jobs due to the floor price/workers who would have been employed
without the floor price.
- beneficial for the workers who were able to keep their jobs because of higher pay.
- to solve this problem, the government could give incentives to the firms to prompt the firms to hire more workers (basically
shifting the demand by the firms to the right). and if the floor price is met, it will be the new P* and there will be an accompanying
Q*.
PRICE CONTROL: PRICE CEILING (Pc)

Price ceiling - aka the maximum price policy or the upper limit on a price.
- commonly applied on jeepney and other transport fares, rent control.
- usually set below the equilibrium price and causes a shortage in the market.
- will not have impact (ineffective) if set above the equilibrium price.

- permanent shortage (because equilibrium will not be reached unless the ceiling if removed)
- intended for the benefit of the consumers. however, this comes again with repercussions especially in some
cases such as in rent.

- dismayed renters - would have been renting a house without the ceiling.
- beneficial for those who managed to stay renting houses.
- to solve this, the government could incentivize again the landowners for them to allow more houses to be rented or
create new ones (basically shifting the supply curve to the right). as a consequence, new P* and Q* will result if ever the shortage is
completely solved.
Impacts of Price Ceilings:
- shortages in the good whose price is controlled (yeah)
- hoarding by sellers
- creation of “black markets”, “shadow markets” where the good can be available at a higher price to willing buyers.

ELASTICITY CONCEPTS

Elasticity - measures the responsiveness of Y to changes of X (if Y=f(X)).

- indicates the percentage change in Y in response to one percent change in X.

Demand Elasticity

Own Price Elasticity of (Quantity) Demand

- own price elasticity of demand measures the responsiveness of quantity demanded of a good to changes in its own
price.

Two Ways of Estimating Elasticity

1. Point Elasticity - elasticity is measured for a single point on the demand curve
- more precise since elasticity can be different at every point on a demand curve.
- this can be obtained if the demand function is known.
 2. Arc Elasticity - computed using two points along a demand curve
- implemented if there are a limited number of observations.

How to interpret?
Own price elasticity of (quantity) demanded should always be negative value to show inverse relationship.

Elasticity along a linear demand curve.

- constant slope
- elasticity = falls as you move down the demand curve. becomes inelastic at some point.
- unit elastic at the midpoint of the demand curve

If linear curve, use the point elasticity.

Perfectly inelastic (vertical demand curve) - any change in price will not change Qd.
- elasticity = 0, slope = infinity
Perfectly elastic (horizontal demand curve) - a small change in price will lead to an infinity change in Qd.
Elasticity = infinity, slope= 0

The elasticity of a good has an impact to the revenue changes of a good:

Total Revenue (TR) = P x Q

What happens to TR when P increases?

– If (quantity) demand is elastic, higher price leads to lower TR
– If (quantity) demand is inelastic, higher price leads to higher TR
– If (quantity) demand is unit elastic, higher price does not affect TR.

Determinants of the own price elasticity of demand:

. Availability of Substitute (more substitute, more elastic)
. Price of the good relative to purchasing power (larger share of the budget, more elastic)
. Time frame under consideration (longer period, more elastic)
. Location along the demand curve (refer to the linear demand curve)
Cross-Price Elasticity of Demand
- measures the responsiveness of the demand for a good to changes in the price of another good.

if equals to zero = the goods are not related.

Income Elasticity of Demand

- measures the responsiveness of the demand for a good to a change in income.

n>1, luxury
0<n<1, necessity

Price Elasticity of Supply

- measures the degree of responsiveness of quantity supplied to changes in the own price of the good.
TAX INCIDENCE
Two types of taxes:
1. Specific/excise tax = tax per unit of the product.
2. Ad valorem = tax as a percentage of the selling price

Take-aways:
1. Tax will raise the equilibrium price.
2. The increase in the equilibrium price is likely to be less than the amount of tax.
. The burden of the tax (who pays?) is generally shared by producers and consumers

– will mainly be augmented in the supply curve.

– tax shifts up the supply curve.

– producers will be unable to raise the price so that the consumers will pay all tax. not possible.
– if the price elasticity of the (quantity) demand of the good is inelastic or perfectly inelastic, the tax burden is more on the
consumers.

– if the price elasticity of the (quantity) demand of the good is elastic or perfectly elastic, the tax burden is more on the
producers. however, there’s a repercussions since the producers will likely produce less.