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# Supply and demand

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### Supply and demand

1. 1. DEMAND & SUPPLY IN ACTION CH.6
2. 2. Price Ceilings A price ceiling is a legal restriction on the price of the product. In particular, it is a legal maximum price. Suppose that the maximum price for a bottle of milk was 1.000.000 TL. This means that any price from 1.000.001TL or higher is illegal, and any price of 1.000.000 TL or lower is legal.
3. 3. P Table #1 Demand & Supply for Ice Cream Q Q \$2.00 125 75 \$2.25 120 80 \$2.50 110 85 \$2.75 105 95 \$3.00 100 100 \$3.25 95 110 \$3.50 90 115 \$3.75 85 120 \$4.00 80 125 D S
4. 4. • What is the equilibrium price for ice cream? (\$3) • What happens if a price ceiling of \$2.00 per cone is put in effect? • It will cause a shortage of ice cream cones equal to 50 units. Why? Because at \$2.00 per cone, quantity demanded equals 125 while quantity supplied is only 75.
5. 5. Effects of Price Ceilings • Shortages - The most common result of effective price ceilings is the fact that quantity demanded exceeds quantity supplied - therefore, a shortage develops in the marketplace. • Rationing of Scarce Goods - Because products with price ceilings tend to be in short supply, rationing becomes an issue. Normally, free markets simply allocate goods to those most willing to pay for them, and everybody who is willing to pay the market price or higher for a good tends to get it. With shortages, the allocation of the product can be arbitrary, inefficient and even unfair.
6. 6. Effects of Price Ceilings • Wasted Time - Another consequence of market shortages is that buyers tend to have to wait in long lines to get the product. The time wasted in line is a negative effect.
7. 7. Price Floors A price floor is a legal restriction on the price of the product. In particular, it is a legal minimum price. Suppose that the minimum price for a bottle of milk was 1.000.000 TL. This means that any price from 1.000.001 TL or higher is legal, and any price of 1.000.000TL or lower is illegal.
8. 8. Effects of Price Floors • Surpluses - The most common consequence of an effective price floor is that the market tends to experience a surplus of the product since a binding price floor holds the market price above the equilibrium price. This high price induces more output by sellers, and less demand from consumers. • Rationing Among Sellers - Since there is a surplus of the product, there is rationing among sellers that is inefficient and often unfair, just like the rationing among buyers that occurred with a price ceiling.
9. 9. Taxes • Taxes on Buyers - When buyers are taxed by the government, we depict this as a downward shift in the demand curve. • Taxes on Sellers - When the government collects the tax from sellers (like with sales tax), we depict this as an upward shift in the supply curve.
10. 10. Tax Incidence Tax Incidence is the study of who bears the burden of taxes. The interaction of price elasticity of demand and price elasticity of supply determine whether the sellers or the buyers bear the greater burden .
11. 11. When demand is relatively inelastic, quantity demanded will NOT fall by a large amount. Therefore, buyers continue to purchase the product after the tax is imposed and this causes them to pay a larger share of the tax. When demand is relatively ELASTIC consumers greatly reduce their purchases of the product. Since consumers buy a lot smaller quantity after the tax is imposed, they avoid paying the tax - therefore, sellers pay a larger portion of the tax.