Lecture 3

1.

Microeconomics
Dr. Shahab Sharfaei, PhD.
UNYP

2.

Lecture 2
Supply, Demand, the
Equilibrium, and Government
Policies

3.

Market mechanism‘s elements
• Demand
• Supply
• Price
• Competition
3

4.

Demand (D)
4
Demand - Quantity of goods (products and services)
that consumers are willing to buy at various prices
Quantity Demanded - the amount of goods that
households would buy in a given time period if they
could buy all they wanted at the current market price.

5.

Demand (D)
• The law of demand states that there is a negative, or
inverse relationship between the price and the
quantity of goods demanded
5

6.

Law of Demand

7.

Movement Along the Demand Curve

8.

Shift of the Demand Curve

9.

Changes in Market Equilibrium
Exercise
1.Why does the demand curve shift?
• To the right
• To the left

10.

Key terms
• Income effect
• Substitutes-in-consumption
• Substitution effect
• Inferior goods
• Normal goods
• Independent goods

11.

Determinants of Demand

12.

Determinants of Demand
a) Factors that affect only the quantity demanded
(the shift along the curve)
• Price - The Income Effect
- The Substitution Effect
b) Factors that cause a change in demand (the
whole demand curve shifts)
• Income
• Prices of substitutes and compliments
• Specific and subjective factors (expectations,
preferences)
12

13.

Exercise
• Which of the following would not be a determinant of the
demand for a particular good?
a) prices of related goods
b) income
c) tastes
d) the prices of the inputs used to produce the good
e) fashion

14.

Income Change Effect of Superior Goods
P
Income Growth
D0
P
D1
D1
Q
14
Income Decline
D0
Q

15.

Income Change Effect of Inferior Goods
Income Growth
15
Income Decline

16.

Related Goods Change Effect - Substitutes
Substitute price decline
Substitute price increase
15

17.

Related Good Change Effect - Complements
Complement Price Decline
Complement Price Increase
16

18.

Self-test
• What type of relationship do apps and smartphones have? If price of
smartphones increases, what do you expect to happen to the
demand of apps?

19.

Supply (S)
• Supply - Quantity of goods that firms are willing
to sell at various prices
• Quantity supplied – the amount of a good that firms
want to sell at a given price (holding constant other
factors that influence firms‘ supply decisions, such
as costs and government actions)
• Supply curve – the quantity supplied at each
possible price (holding constant other factors that
can influence it)
19

20.

The Law of Supply
• states that there is a positive (directly proportional)
relationship between the price and the quantity of
goods supplied
20

21.

Law of Supply

22.

Movement Along the Supply Curve

23.

Shift of the Supply Curve

24.

Changes in Market Equilibrium
Exercise
1.Why does the supply curve shift?
• To the right
• To the left
2. Why do supply curves slope upwards?

25.

Determinants of Supply

26.

Determinants of Supply
a) Factors that affect only the quantity supplied
(the shift along the curve) - Price
b) Factors that cause a change in supply (the
whole supply curve shifts)
26
Changes in production costs
Changes in the price of alternative products
(production substitutes, complements)
Prices of products resulting from one
manufacturing process
Market organization
Specific factors
Changes in expectations

27.

Determinants of Supply
• Substitutes-in-production
• Complements-in-production

28.

How Will Future Supply and/or Quantity Supplied
Change?
(under the ceteris paribus assumption)
a) Boston Consulting predicts that Chinese companies
will use robots to reduce labor costs by 18%.
b) Jonathan, an executive automotive analyst for the
American Automobile Dealers Association's used car
guide, predict that prices of used cars will drop
between 2 and 2.5 percent in 2022.
c) Across the nation, there is talk of an increase in
minimum wage.

29.

How Will Supply and/or Quantity Supplied Change?
(under the ceteris paribus assumption)
d) The median price of an existing single-family home
rose from a year earlier in 86% of the 175
metropolitan areas measured, the National
Association of Realtors said in an expert report.
How will this news influence behavior of building
contractors who construct multi-family apartment
buildings and single-family houses?

30.

Derivation of a Market Supply Curve

31.

Exercise
• If bread is an inferior good, then what will happen in the
market for bread as the consumer income increases?
a) the quantity will increase.
b) the quantity will decrease.
c) the price will fall.
d) both a) and c) are correct.
e) both b) and c) are correct.

32.

Exercise
• Two goods are substitutes if a decrease in the price of one
good
a) decreases the demand for the other good.
b) decreases the quantity demanded of the other good.
c) increases the demand for the other good.
d) increases the quantity demanded of the other good.
e) doesn't influence the other good
f) increases the price of other good

33.

How Will Future Demand and/or Quantity Demanded Change?
(under the ceteris paribus assumption)
a) With just a handful of exceptions, the latest round of
publication paper price negotiations ended with
manufacturers forced to make more concessions in
France (i.e. substantially cut their prices). How will
newspaper buyers react?
b) Chinese vintners are pinning their hopes on the 2022
Olympic Games. Why?
c) Apple will improve iPhone cameras with use of mirrors.
d) Gov. Sam Brownback has proposed large increases in
tobacco taxes from 10% of an item's wholesale price to
25% of that price.

34.

How Will Demand and/or Quantity Demanded Change?
(under the ceteris paribus assumption)
e) In 2015 Canon reduced the price of their 4K
video DSLR, the Canon EOS 1DC, by $4,000.
How will this news affect Nikon D4S?

35.

Market Demand
Market Demand
35

36.

Exercise
• If the government announces today that a tax increase of 50
cents per pack of cigarettes is to take place in two weeks, what
would you expect to happen today to the current market for
cigarettes?
a) the demand for cigarettes would increase.
b) the demand for cigarettes would decrease.
c) the price of cigarettes would increase.
d) both a) and c) are correct.
e) both b) and c) are correct.

37.

Market Equilibrium
Equilibrium price is also known as market-clearing price

38.

Exercise
• Assume cars and gasoline are complements. When the price of
gasoline goes up, which of the following will happen to the
market for cars?
a) the equilibrium price of cars will increase.
b) the equilibrium quantity of cars will decrease.
c) the supply curve for cars will shift to the left.
d) the supply curve for cars will shift to the right.
e) the demand curve for cars will shift to the right.
f) none of the above.

39.

Exercise
• Suppose that the price of basketball tickets at MUP is determined by
market forces. Currently, the demand and supply schedules are as
follows:
Price
(Czech crowns)
Quantity
Demanded
Quantity
Supplied
100
150
180
200
230
10,000
8,000
6,000
4,000
2,000
8,000
8,000
8,000
8,000
8,000
• What are PE and QE of tickets?
• Draw D and S. What is unusual about this S?

40.

Exercise
• Suppliers produce two goods, cheese and butter. Assume that there
is no cost to switch resources from cheese production to butter
production and vice versa. Suppose the demand for butter increases.
What do we expect to happen to the equilibrium in the market for
cheese?
a) the price will go up and the quantity will drop.
b) the price will go up and the quantity will rise.
c) the price will go down and the quantity will drop.
d) the price will go down and the quantity will rise.
e) none of the above.

41.

Relevant Literature
• Mankiw „Principles of Microeconomics“: Chapter 4
(„The Market Forces of Supply and Demand“)

42.

I. Controls on Prices

43.

Market Outcomes
• In a free, unregulated market system, market forces establish equilibrium
prices and exchange quantities.
• While equilibrium conditions may be efficient, they may not always be fair.
• Governments seek to influence unfair markets.

44.

Price Ceiling and Floor
Price controls are usually enacted when policymakers believe the market
price is unfair to buyers or sellers.
•Result in government-created price ceilings and floors.
• Price Ceiling: A legal maximum on the price at which a good can be sold.
• Price Floor: A legal minimum on the price at which a good can be sold.

45.

How Price Ceilings Affect Market
Outcomes
•When the government imposes a price ceiling there are two possible
outcomes:
• The price ceiling is not binding if set above the equilibrium price.
• The price ceiling is binding if set below the equilibrium price, leading to a shortage.

46.

How Price Ceilings Affect Market Outcomes
Figure 1: A Market with a Price Ceiling that is not binding
Price of
flats per
sq m
Supply
€40
Price
ceiling
30
Equilibrium
price
Demand
0
5,000
Equilibrium
quantity
Quantity of rental
accommodation
(millions m2)

47.

How Price Ceilings Affect Market Outcomes
Figure 1. A Market with a Price Ceiling that is
binding
Price of
flats per
sq m
Supply
Equilibrium
price
€30
Price
ceiling
20
Shortage
Demand
0
4,000
6,000
Quantity
supplied
Quantity
demanded
Quantity of rental
accommodation
(millions m2)

48.

How Price Ceilings Affect Market Outcomes
• Effects of Price Ceilings
• A binding price ceiling creates
• Shortages because QD > QS. Example: Rent controls in a city may restrict new
building.
• Non-price rationing. Examples: Long queues; discrimination by sellers.

49.

50.

Price Ceilings in
Venezuela
• In 2003, Venezuela imposed
price ceilings on various
basic (mainly food) items
• By late 2009, roughly 400
items had mandated price
ceilings

51.

Price Ceilings in Venezuela
• Venezuela has been plagued by food shortages ever
since
• It has been difficult to find food at regulated prices
• Consumers had to wait in long lines
• In a 2012 survey, powdered milk could not be found
in 42 percent of grocery establishments

52.

Price Ceilings in Venezuela
• Food companies have attempted to alter their
products to versions that are not regulated
• For example, the price of white rice is regulated, but
the price of flavoured rice is not
• Government imposed production quotas to force
producers to produce more of foods with price
ceilings
• Rice companies were required to have 80 percent of
their production sold as white rice

53.

Price Ceilings in Venezuela
• Companies responded by limiting total production
• In 2009, the government seized control of several
food processing factories
• The government is also contending with increased
smuggling of low priced food into Columbia

54.

Price controls
• In competitive markets, we do not expect to observe
shortages or surpluses (markets clear)
• Shortages or surpluses often result from government
controls of prices

55.

Price controls
• Assume that a hurricane destroys roads and
buildings, and brings down power plants
• Consequently, many shops are closed and
supplies are interrupted
• Sellers take advantage of the situation and raise
prices to increase their profits
• Assume that you are a mayor of the affected
city
• Would you freeze prices in order to prevent the
increase in prices?

56.

How Price Floors Affect Market Outcomes
•When the government imposes a price floor there are two possible
variations.
• The price floor is not binding if set below the equilibrium price.
• The price floor is binding if set above the equilibrium price, leading to a surplus.

57.

How Price Floors Affect Market Outcomes
Figure 2a. A Market with a Price Floor that is not binding
Price of
alcohol per
unit (€)
Supply
Equilibrium
price
€0.35
Price
floor
0.25
Demand
0
5
Equilibrium
quantity
Quantity of
alcohol per unit
(millions)

58.

How Price Floors Affect Market Outcomes
Figure 2b. A Market with a Price Floor that is
Binding
Price of
alcohol per
unit (€)
Supply
Surplus
€0.45
Price
floor
0.35
Equilibrium
price
Demand
0
3
6
Quantity Quantity
demanded supplied
Quantity of alcohol
per unit (millions)

59.

Price Floor
The minimum prices of production (price higher than the equilibrium)
QD <QS
E.g. subsidized prices of agricultural produce. There is
overproduction.

60.

How Price Floors Affect Market Outcomes
• A price floor prevents supply and demand from moving toward the
equilibrium price and quantity.
• When the market price hits the floor, it can fall no further, and the market price equals
the floor price.
• A binding price floor causes a surplus because QS > QD.

61.

Price Controls
• Price controls are used when governments or other agencies believe that the
market is not allocating resources equitably (even if it is allocating resources
efficiently).
• But there are other options which we will now explore.

62.

Video
• https://youtu.be/dnj2WRIG11U?si=-ck8TnpEz1cilBA5

63.

II. Taxes

64.

Introduction to Taxes
• Governments levy taxes to raise revenue for public projects.
• However,
• Taxes discourage market activity.
• When a good is taxed, the quantity sold is smaller.
• Buyers and sellers share the tax burden.

65.

Introduction to Taxes
•A direct tax is levied on income and wealth
•Indirect tax is levied on the sale of goods and
services.

66.

How Taxes on Sellers Affect Market Outcomes
• A Specific Tax where the government requires the seller to pay a certain
amount for each good sold.
• Quantity sold falls.
• Even though the tax is levied on sellers, buyers and sellers will share the burden of
the tax; buyers pay more for the good and sellers receive less (because of the tax).

67.

Elasticity and Tax Incidence
•Implications of tax.
• Taxes result in a change in market equilibrium. Taxes discourage market activity.
• Buyers pay more and sellers receive less, regardless of whom the tax is levied on.
Buyers and sellers share the tax burden.
Tax incidence is the manner in which the burden of a tax is shared among market
participants.

68.

IV. The Tax System

69.

Taxes and Efficiency
• Governments raise taxes to:
Help pay for the various services that government provides.
Influence behaviour and achieve market outcomes that are deemed
desirable.
• The Cost of Taxes to Taxpayers.
The tax payment itself.
Deadweight losses.
Administrative burdens.

70.

Taxes and Efficiency
Two objectives when designing a tax system are efficiency
and equity.
One tax system is more efficient than another if it raises the same
amount of revenue at a smaller cost to taxpayers and the
government.
Efficient taxes have small deadweight losses and low administrative
burdens.
Taxes affect consumer and producer behaviour and produce
different market outcomes compared to free market outcomes.

71.

V. The Deadweight Loss of
Taxation

72.

An Introduction
• A tax on a product means:
• The price that a buyer pays will be greater than the price the seller receives.
•Tax Revenue
• T = the size of the tax
• Q = the quantity of the good sold
T Q = the government’s tax revenue

73.

Deadweight Loss and Tax Revenue as Taxes Vary
o For the small tax, tax revenue is small.
o As the size of the tax rises, tax revenue grows.
o But as the size of the tax continues to rise, tax revenue falls because the higher
tax reduces the size of the market.
o
As the tax increases, the level of tax revenue will eventually fall.

74.

VI. Administrative Burden

75.

A Second Cost of Tax
• Complying with tax laws creates additional deadweight losses.
• Taxpayers spend time and money documenting, computing, and filling
tax forms.
• These are additional administrative costs they incur, over and above
the actual taxes they pay.
• The administrative burden of any tax system is part of the inefficiency it
creates.

76.

VII. The Design of the Tax System

77.

Adam Smith’s Four Canons of Taxation
1. Equality
o Each person should pay taxes according to their
ability to pay.
2. Certainty
o
Taxpayers need to know what taxes they owe, and governments
should have some certainty in how much they are able to collect in
taxes.
3. Convenience
o
Paying taxes should be made as easy as possible
4. Economic
o
The cost of collecting and administering taxes must be less than the
amount collected.

78.

Marginal Tax Rates versus Average Tax Rates
•The average tax rate is total tax paid divided by total income.
•The marginal tax rate is the extra tax paid on an additional pound of
income.

79.

Lump-Sum Taxes
• A lump-sum tax is a tax that is the same amount for every person,
regardless of earnings or any actions that the person might take.
• For this type of tax, the marginal tax rate is equal to zero.
• This is the most efficient type of tax.
• It does not distort incentives
• Little administrative burden

80.

Summary
1)
2)
3)
4)
5)
6)
Price controls include price ceilings and price floors.
A price ceiling is a legal maximum on the price of a good or service. An example is rent control.
A price floor is a legal minimum on the price of a good or a service. An example is the minimum
wage.
Taxes are used to raise revenue for public purposes.
The incidence of the tax depends on the price elasticities of supply and demand.
The burden tends to fall on the side of the market that is less price elastic.

81.

Summary
7)
A tax on a good reduces the welfare of buyers and sellers of
the good, and the reduction in consumer and producer
surplus usually exceeds the revenues raised by the
government.
8)
The fall in total surplus—the sum of consumer surplus,
producer surplus, and tax revenue — is called the
deadweight loss of the tax.
9)
Taxes have a deadweight loss because they cause buyers to
consume less and sellers to produce less.
10) This change in behaviour shrinks the size of the market
below the level that maximizes total surplus.