Analysis of Supply, Demand, and Government Policies: Economics Ch. 6

This economics assignment, submitted by Group D, delves into the core concepts of supply, demand, and the impact of government policies. The assignment begins by defining and providing examples of price ceilings and price floors, illustrating how these interventions lead to shortages and surpluses, respectively. It then explores the mechanisms that allocate resources when prices are not at equilibrium, highlighting the role of rationing. The assignment further examines economists' opposition to price controls, emphasizing the efficiency of market-driven prices. A significant portion of the assignment is dedicated to analyzing the effects of taxes on both buyers and sellers, including how the tax burden is distributed and the impact on market prices and quantities. The assignment also applies these concepts to practical scenarios, such as the impact of price ceilings on concert tickets, price floors on cheese, and taxes on beer and Frisbees. Finally, it considers the implications of payroll tax adjustments on workers and firms. The assignment demonstrates a strong understanding of supply and demand principles, market equilibrium, and the consequences of government intervention.

Chapter 6
SUPPLY, DEMAND, AND GOVERNMENT
POLICIES
Submitted 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
\
Supply
Price Ceiling
Demand
Equilibrium
Price
10
Price of Mask
Quantity of Mask
Quantity
Supplied
Quantity
demanded
9
75 125
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.
Price of cheese
Quantity of cheese
Supply
SurplusP2=$8
P1=$5
Equilibrium
price
0
Quantity
demanded
Q1=40 Q2=150Quantity
supplied
Demand
Q=100

Therefore, by imposing the binding price floor, the price is set at a higher level than the
equilibrium price, while the quantity sold falls below the equilibrium quantity. Also, as
the quantity supplied (Q2) exceeds the quantity demanded (Q1), there occurs a supply
surplus. So, the market situation is given on the graph below through the supply curve (S)
and demand curve (D) for cheese.
3. A recent study found that the demand and supply schedules for Frisbees are as
follows:
Price per Frisbee Quantity Demanded Quantity Supplied
$11 1 million Frisbees 15 million Frisbees
10 2 12
9 4 9
8 6 6
7 8 3
6 10 1
a. What are the equilibrium price and quantities of Frisbees?
In the Chart below, demand and supply curve of Frisbee is shown.
Quantity demanded and supplied is in X-axis and Price is in Y-axis. D is
the demand curve, S is the supply curve and E is the equilibrium point.
Equilibrium price of the Frisbee is $8 and equilibrium quantity is 6 million
on the basis of demand and supply curve.
0 2 4 6 8 10 12 14 16
0
2
4
6
8
10
12
Demand and supply curve
D
S
Quantity demand and supply
Price of Frisbee E
b. Frisbees manufacturers persuade the government that Frisbee production
improves scientists’ understanding of aerodynamics and thus is important for
national security. A concerned Congress votes to impose a price floor $2 above
the equilibrium price. What is the new market price? How many Frisbees are
sold?
i. The new market price is $10(8+2).

ii. Quantity sold is 2 million only.
0 2 4 6 8 10 12 14 16
0
2
4
6
8
10
12 Demand and supply curve
D
S
Quantity demand and supply
Price of Frisbee
E
Qd Q
s
F
It can be explained with the following chart. Here, F is price floor curve
which is $10. Quantity supplies is 12 million and demanded is 2 million.
So new market price is $10 and Frisbees actually sold is 2 million.
c. Irate College students march on Washington and demand a reduction in the
price of Frisbees. An even more concerned Congress votes to repeal the price
floor and impose price ceiling $1 below the former price floor. What is the
new market price? How many Frisbees are sold?
After imposing $1 Price ceiling below the price floor the demand and
supply curve of Frisbees will be as follows.
0 2 4 6 8 10 12 14 16
0
2
4
6
8
10
12
Demand and supply curve
D
S
Quantity demand and supply
Price of Frisbee
Qd Q
s
C
Here, C is the price ceiling, Qd is quantity demanded and Qs is the
quantity supplied. Therefore, the new market place is $9, quantity
demanded is 4 million, quantity supplied is 9 million but actual quantity
sold is 4 million.

4. Suppose the federal government requires beer drinkers to pay a $2 tax on each
case of beer purchased. (In fact, both the federal and state governments impose
beer taxes of some sort.)
a. Draw a supply-and-demand diagram of the market for beer without the tax. Show
the price paid by consumers, the price received by producers, and the quantity of
beer sold. What is the difference between the price paid by consumers and the
price received by producers?
0 2 4 6 8 10 12
0
2
4
6
8
10
12
Demand and supply curve
D
S
Quantity demand and supply
Price of beer
Qs
In the free market without any tax, market equilibrium is determined through
demand and supply. At equilibrium price, quantity buyer wants to buy is equal to
quantity seller wants to sell. Here, in our example, equilibrium price is $7.1 and
equilibrium quantity is 3.6 million. So, price perceived by the consumer and
seller is equal to $7.1, and amount sold is 3.6 million. There is no difference in
price paid by buyers and price perceived by sellers.
b. Now draw a supply and demand diagram for the beer market with the tax. Show
the price paid by consumers, the price received by producers, and the quantity of
beer sold. What is the difference between the price paid by consumers and the
price received by producers? Has the quantity of beer sold increased or
decreased?
Here, Tax paid by consumer is denoted as C which is $1.4 and tax paid by
producer is denoted by P which is $0.6. Price paid by consumer is $10 and
the price received by producer is $6, and the quantity of beer sold is
denoted as Qs in the diagram that is 1 million. Difference between price

paid by consumer and received by producer is $2. Quantity of beer sold
has decreased by 2.6 million.
0 2 4 6 8 10 12
0
2
4
6
8
10
12
Demand and supply curve
D
S
Quantity demand and supply
Price of beer C
P
Qs
5. A senator wants to raise tax revenue and make workers better
off. A staff member proposes raising the payroll tax paid by firms
and using part of the extra revenue to reduce the payroll tax paid
by workers. Would this accomplish the senator’s goal? Explain
Reducing the payroll tax paid by firms and using part of the extra
revenue to reduce the payroll tax paid by workers would not make
workers better off, because the division of the burden of tax depends
on the elasticity of supply and demand and not on who must pay the
tax. Because the tax wedge would be larger, it is likely that both firms
and workers, who share the burden of any tax, would be worse off.
6. If the government places a $500 tax on luxury cars, will the price
paid by consumers rise by more than $500, less than $500, or
exactly $500? Explain
If the government imposes a $500 tax on luxury cars, the price paid
by consumers will raise less than $500, in general. The burden of any
tax is shared by both producers and consumers the price paid by
consumers rises and the price received by producers falls, with the
difference between the two equal to the amount of the tax. The only
exceptions would be if the supply curve were perfectly elastic or the
demand curve were perfectly inelastic, in which case consumers would
bear the full burden of the tax and the price paid by consumers would
rise by exactly $500

7. Congress and the president decide that the United States should reduce air
pollution by reducing its use of gasoline. They impose a $0.50 tax on each gallon
of gasoline sold.
a. Should they impose this tax on producers or consumers? Explain carefully
using a supply-and-demand diagram.
It does not matter whether the tax is imposed on producers or
consumersthe effect
will be the same. With
no tax, as shown in the
figure, the demand
curve is D1 and the
supply curve is S1. If
the tax is imposed on
producers, the supply
curve shifts upward by
the amount of the tax
(50 cents) to S2. Then the equilibrium quantity is Q2, the price paid by
consumers is P2, and the price received (after taxes are paid) by producers
is P2 – 50 cents. If the tax is instead imposed on consumers, the demand
curve shifts downward by the amount of the tax (50 cents) to D2. The
downward shift in the demand curve (when the tax is imposed on
consumers) is exactly the same magnitude as the upward shift in the
supply curve when the tax is imposed on producers. So again, the
equilibrium quantity is Q2, the price paid by consumers is P2 (including
the tax paid to the government), and the price received by producers is P2
– 50 cents.

b. If the demand for gasoline were more elastic, would this tax be more effective
or less effective in reducing the quantity of gasoline consumed? Explain with
both words and a diagram
The more elastic the demand curve, the more effective this tax will be in
reducing the quantity of
gasoline consumed. Greater
elasticity of demand means
that quantity falls more in
response to the rise in the
price. The figure illustrates
this result. Demand curve
D1 represents an elastic demand curve, while demand curve D2 is more
inelastic. The tax will cause a greater decline in the quantity sold when
demand is elastic.
c. Are consumers of gasoline helped or hurt by this tax? Why?
The consumers of gasoline are hurt by the tax because they get less
gasoline at a higher price.
d. Are workers in the oil industry helped or hurt by this tax? Why?
Workers in the oil industry are hurt by the tax as well. With a lower
quantity of gasoline being produced, some workers may lose their jobs.
With a lower price received by producers, wages of workers might
decline.

8. A case study in this chapter discusses the federal minimum-wage law.
a. Suppose the minimum wage is above the equilibrium wage in the market for
unskilled labor. Using a supply-and-demand diagram of the market for
unskilled labor, show the market wage, the number of workers who are
employed, and the number of workers who are unemployed. Also show the
total wage payments to unskilled workers
The figure shows the effects of
the minimum wage. In the
absence of the minimum wage,
the market wage would be w1
and Q1 workers would be
employed. With the minimum
wage (wm) imposed above w1,
the market wage is wm, the
number of employed workers is
Q2, and the number of workers who are unemployed is Q3 − Q2. Total
wage payments to workers are shown as the area of rectangle ABCD,
which equals wm times Q2.
b. Now suppose the secretary of labor proposes an increase in the minimum
wage. What effect would this increase have on employment? Does the change
in employment depend on the elasticity of demand, the elasticity of supply,
both elasticity's, or neither?
An increase in the minimum wage would decrease employment. The size
of the effect on employment depends only on the elasticity of demand.
The elasticity of supply does not matter, because there is a surplus of
labor.

c. What effect would this increase in the minimum wage have on
unemployment? Does the change in unemployment depend on the elasticity
of demand, the elasticity of supply, both elasticities or neither?
The increase in the minimum wage would increase unemployment. The
size of the rise in unemployment depends on both the elasticities of supply
and demand. The elasticity of demand determines the change in the
quantity of labor demanded, the elasticity of supply determines the change
in the quantity of labor supplied, and the difference between the quantities
supplied and demanded of labor is the amount of unemployment.
d. If the demand for unskilled labor were inelastic, would the proposed increase
in the minimum wage raise or lower total wage payments to unskilled
workers? Would your answer change if the demand for unskilled labor were
elastic?
If the demand for unskilled labor were inelastic, the rise in the minimum
wage would increase total wage payments to unskilled labor. With
inelastic demand, the percentage decline in employment would be lower
than the percentage increase in the wage, so total wage payments increase.
However, if the demand for unskilled labor were elastic, total wage
payments would decline, because then the percentage decline in
employment would exceed the percentage increase in the wage.