Chapter 6: Supply, Demand, and Government Policies

Chapter 6
SUPPLY, DEMAND, AND GOVERNMENT
POLICIESSubmitted by
Group D
Aanya Shah
Manoj Dhakal
Niki Shrestha
Sabina Ghimire
Suruchi Maharjan
Review Questions 1. Give an example of a price ceiling and an example of a price floor.
A price floor is a minimum price at which a product or service is permitted to
sell. An important example of a price floor is the maximum wage. A price
ceiling is a maximum price that can be charged for a product or service. Rent
control imposes on maximum price on apartments in Kathmandu.
2. Which causes a shortage of a good – a price ceiling or a price floor? Justify your
answer with a graph.
Price ceiling causes a shortage of a good. In the below figure, the government
imposes a price ceiling of $9. Because the price ceiling is below the
equilibrium price of $10.At this price, 125 masks are demanded and only 75
are supplied, so there is a shortage of 50 masks
\
75 125
Quantity
demanded
Quantity
Supplied
9
Quantity of Mask
10
Equilibrium
Price
Demand
Price Ceiling
SupplyPrice of Mask
Demand

3. What mechanisms allocate resources when the price of a good is not allowed to
bring supply and demand into equilibrium?
Government uses various policies to control inequities in the market. Price
ceiling, price floor, tax are some of the tools that government use to affect market
outcomes, so that it’ll be fair for both buyers and sellers. In normal market,
equilibrium price allocates the resources but in the market where government
intervenes, these policies will control price of a good and won’t allow it to bring
supply and demand into equilibrium.
In such cases, market creates other mechanisms to allocate resources such
as rationing mechanism. For example; when government imposes binding price
ceiling on a competitive market, demand of the goods exceeds the supply of the
goods and it creates shortage in the market. There will be large number of
potential buyers and low number of suppliers with low quantity of goods to fulfill
the demand. So, sellers must ration the scarce goods among the large number of
potential buyers.
4. Explain why economists usually oppose controls on prices.
Economists usually oppose controls on prices because according to the Ten
Principles of Economics, markets are usually a good way to organize economic
activity. Price is the invisible hand which directs economic activities allocating
resources in the market. Buyers determine how much to demand and sellers
determine how much to sell according to the market prices. As, a result it reflects
the value of the goods and cost of making it. Prices adjust to guide these
individual buyers and sellers to reach outcomes that maximizes the well-being of
society as a whole.
When government oppose controls on prices, it prevents prices from
adjusting naturally to supply and demand. This will affect the signals that
normally guide the allocation of society’s resources. For example; price ceiling
creates shortage of goods and price floor creates surplus of goods and allocation
of resources will be inefficient.
Even if policies are created to diminish the inequity or unfairness of the market,
these policies will often hurt those they are trying to help. For example, Price
ceilings are created to protect buyers, it creates shortage in the market and buyers
won’t be able to get resources as much as they need. Therefore, economist usually
oppose controls on prices.

5. Suppose the government removes a tax on buyers of a good and levies a tax of
the same size on sellers of the good. How does this change in the tax policy affect
the price that buyers pay sellers for this good, the amount buyers are out of
pocket(including any tax payments they make), the amount sellers receive(net of
any tax payments they make), and the quantity of the good sold?
Taxes levied on sellers and taxes levied on buyers at the same amount; cause the
same consequences on the price and quantity of a good. The only difference
between these two taxes refers to issues of who is obliged to send money to the
government, sellers or buyer’s. Either as the tax is levied on buyers or sellers,
both of them share the burden of a tax.
So, in both cases the price paid by the buyers to the sellers at the new
equilibrium is higher than the equilibrium price without tax. Therefore, in the case
that tax levies are transferred from the buyers to the sellers, the price will remain
unchanged, but also greater than the equilibrium price with the tax.
Also, the quantity sold remains unchanged, but lower than the quantity at
equilibrium price with the tax.
Further, in case of such a change in tax policy, the amount buyers are out
of pocket including the tax and the amount sellers receive net of the tax, remain
unchanged.
6. How does a tax on a good affect the price paid by buyers, the price received by
sellers, and the quantity sold?
A tax on a good raise the price buyers pay lowers the price sellers receive, and
reduces the quantity sold
7. What determines how the burden of a tax is divided between buyers and sellers?
Why?
The burden of a tax is divided between buyers and sellers depending on the
elasticity of demand and supply. More the curve is elastic less the consumer or
supplier will share the burden.
Suppose, demand curve is inelastic and supply curve is elastic, in the
condition the burden of tax is more on consumer than that on supplier.When the
good is taxed the side of the market with fewer good alternatives cannot easily
leave the market and thus bears the more of the burden of the tax.

Problems and Applications
1. . Lovers of classical music persuade Congress to impose a price ceiling of $40 per
concert ticket. As a result of this policy, do more or fewer people attend classical
music concert.
If there is no price control, the price is above $40 per ticket, then if the
government imposes a price ceiling of $40. This will lead to more demand and
which automatically cause shortage of tickets. And also, less people will come
because of the shortage of tickets. The decrease in price will lead to excess
demand for tickets. Sadly, not everyone will be able to go to the concert.
2. The government has decided that the free-market price of cheese is too low.
a. Suppose the government imposes a binding price floor in the cheese market.
Draw a supply- and- demand diagram to show the effect of this policy on the
price of cheese and the quantity of cheese sold. Is there a shortage or surplus
of cheese
Binding price floor refers to the minimum price imposed by the government for
trading in certain good or services, which is set above the equilibrium price. In
contrast, when the price floor is below the equilibrium price, that price is not
binding, so that market situation is irrelevant.
0
Surplus
SupplyPrice of cheese
Quantity of cheese
Demand
Equilibrium
price P2=$8
P1=$5
Q2=150Q=100Q1=40 Quantity
supplied
Quantity
demanded