Unit 2: Supply, Demand,
and Consumer Choice
1
REMEMBER THE STEPS!
2
Government
Involvement
#1-Price Controls: Floors and Ceilings
#2-Import Quotas
#3-Subsidies
#4-Excise Taxes
3
#1-PRICE CONTROLS
Who likes the idea of having a price ceiling on
gas so prices will never go over $1 per gallon?
4
Price Ceiling
Maximum legal price a seller can charge for a product.
Goal: Make affordable by keeping price from reaching Eq.
P
Gasoline
S
$5
Does this
4
policy help
consumers?
3
Result:
BLACK
Price
MARKETS 2
Ceiling
Shortage
1
(Qd>Qs)
D
o
10
20
30
40
50
60
70
80
Q
5
To have an effect,
a price ceiling must be
below equilibrium
6
Price Floor
Minimum legal price a seller can sell a product.
Goal: Keep price high by keeping price from falling to Eq.
P
Corn
S
$
Surplus
(Qd<Qs)
Price Floor
4
3
Does this
policy help
corn
producers?
2
1
o
D
10
20
30
40
50
60
70
80
Q
7
To have an effect,
a price floor must be
above equilibrium
8
Practice Questions
1. Which of the following will occur if a legal price floor is
placed on a good below its free market equilibrium?
A. Surpluses will develop
B. Shortages will develop
C. Underground markets will develop
D. The equilibrium price will remain the same
E. The quantity sold will increase
2. Which of the following statements about price control is true?
A. A price ceiling causes a shortage if the ceiling price is
above the equilibrium price
B. A price floor causes a surplus if the price floor is below
the equilibrium price
C. Price ceilings and price floors result in a misallocation of
resources
9
D. Price floors above equilibrium cause a shortage
Answer the Questions below then draw
the graphs requested in your notes:
In your notes: draw one S&D graph that shows a price
floor and another that shows a price ceiling
10
Are Price Controls Good or Bad?
To be “efficient” a market must maximize
consumers and producers surplus
P
S
CS
Pc
PS
D
Qe
11
Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and
producers surplus
P
S
Price
FLOOR
Pc
CS
DEADWEIGHT LOSS
The Lost CS and PS.
PS
INEFFICIENT!
D
Qfloor Qe
12
Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and
producers surplus
P
S
CS
Pc
PS
D
Qe
13
Are Price Controls Good or Bad?
To be “efficient” a market must maximize consumers and
producers surplus
P
S
Pc
DEADWEIGHT LOSS
The Lost CS and PS.
CS
INEFFICIENT!
Price
CEILING
PS
D
Qceiling Qe
14
#2 Import Quotas
A quota is a limit on number of imports.
The government sets the maximum amount that
can come in the country.
Purpose:
•To protect domestic producers from a
cheaper world price.
•To prevent domestic unemployment
15
International Trade and Quotas
Identify the following:
1. CS with no trade
2. PS with no trade
3. CS if we trade at
world price (PW)
4. PS if we trade at
world price (PW)
5. Amount we import at
world price (PW)
6. If the government sets
This graphs show the domestic
a quota on imports of
supply and demand for grain.
Q4 - Q2, what happens
The letters represent area.
to CS and PS?
#3 Subsidies
The government just gives producers money.
The goal is for them to make more of the goods
that the government thinks are important.
Ex:
•Agriculture (to prevent famine)
•Pharmaceutical Companies
•Environmentally Safe Vehicles
•FAFSA
18
Result of Subsidies to Corn Producers
Price of Corn
S
SSubsidy
Price Down
Quantity Up
Everyone
Wins, Right?
Pe
P1
D
o
Qe Q1
Q
Quantity of Corn
19
20
#4 Excise Taxes
Excise Tax = A per unit tax on producers
For every unit made, the producer must pay $
NOT a Lump Sum (one time only)Tax
The goal is for them to make less of the goods that
the government deems dangerous or unwanted.
Ex:
•Cigarettes “sin tax”
•Alcohol “sin tax”
•Tariffs on imported goods
•Environmentally Unsafe Products
•Etc.
21
Excise Taxes
Supply
Schedule
P
Qs
$5
140
$4
120
Government sets a $2 per
unit
tax
on
Cigarettes
P
S
$5
4
3
$3
100
$2
80
$1
60
2
1
o
D
40
60
80
100
120
140
Q
22
Excise Taxes
Supply
Schedule
P
Qs
$5 $7
140
$4 $6
120
Government sets a $2 per
unit
tax
on
Cigarettes
P
S
$5
4
3
$3 $5
100
$2 $4
80
$1 $3
60
2
1
o
D
40
60
80
100
120
140
Q
23
Excise Taxes
Supply
Schedule
P
Qs
$5 $7
140
$4 $6
120
P
S
$5
4
Tax is the vertical
distance between
supply curves
3
$3 $5
100
$2 $4
80
$1 $3
60
STax
2
1
o
D
40
60
80
100
120
140
Q
24
Excise Taxes
1.
2.
3.
4.
5.
Identify the
following:
Price before tax
P
Price
consumers pay $5
after tax
Price producers 4
get after tax
Total tax
3
revenue for the
government
2
before tax
Total tax
revenue for the 1
government
o
after tax
S
S
D
40
60
80
100
120
140
Q
25
26
Tax Practice
1.
2.
3.
4.
5.
CS Before Tax
PS Before Tax
CS After Tax
PS After Tax
Tax Revenue
for Government
6. Dead Weight
Loss due to tax
7. Amount of tax
revenue
producers pay
27
Excise Tax
P
S
$14
12
11
8
D
10 12
Q
Excise Tax
P
Stax
1.
2.
S
3.
Pc$14
4.
12
Pp 11
5.
6.
8
D
10 12
Q
Calculate
Tax Per Unit
Total Tax
Revenue
Amount of
Tax paid by
consumers
Amount of
Tax paid by
producers
Total
Expenditures
Total Revenue
for firms
Excise Tax
Calculate
1. CS Before Tax
2. Total Expenditures
Before Tax
3. Tax Per Unit
4. Total Tax Revenue that
goes to Government
5. Amount of Tax paid by
consumers
6. Amount of Tax paid by
producers
7. Total Expenditures after
tax
8. Total Revenue for firms
after tax
9. CS After Tax
10. DWL