Macro Unit 3 - Unit 3 Demand Supply and Government Policies Overview Unit 3 is the third in a three-unit sequence that deals with supply and demand and

Macro Unit 3 - Unit 3 Demand Supply and Government Policies...

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41 Unit 3 Demand, Supply and Government Policies Overview Unit 3 is the third in a three-unit sequence that deals with supply and demand and how markets work. Unit 2 developed the model of supply and demand and added precision to the model by developing the concept of elasticity —the sensitivity of the quantity supplied and quantity demanded to changes in economic conditions. Unit 3 addresses the impact of government policies on competitive markets using the tools of supply and demand that you learned in Unit 2. This Unit is divided into two sessions as follows: Session 1: Controls on Prices Session 2: Taxes These sessions consider two types of government policies—price controls and taxes. Price controls set the maximum or minimum price at which a good can be sold while a tax creates a wedge between what the buyer pays and what the seller receives. These policies can be analysed within the model of supply and demand. We will find that government policies sometimes produce unintended consequences. The main objective of this Unit is to expose you to the impact of government policies on competitive markets using the tools of supply and demand. The first session defines and examines price controls. The second session defines and examines taxes. Unit 3 Learning Objectives At the end of this Unit, you will be able to: analyse the effects of price controls on the markets for goods and services; evaluate the effectiveness of minimum wage laws in helping those who earn low wages; analyse the effects of taxes on the markets for goods and services.
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43 Session 1 Controls on Prices Introduction In this Session, we will be examining the effect of price controls on market outcomes. Price controls are usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers. This Session will analyse these policies using only the tools of demand and supply. The analysis yields some surprising results, because as we shall observe, these policies can generate inequities of their own and therefore often have effects that their architects did not intend or anticipate. Objectives At the end of this Session, you will be able to: analyse the effects of government policies that place a ceiling on prices; analyse the effects of government policies that put a floor under prices; discuss minimum wage laws. Price Floors and Price Ceilings We saw in Unit 2, that if ice cream cones are sold in a competitive market free of government regulation, the price of ice cream cones adjusts to balance demand and supply: At the equilibrium price, the quantity of ice cream cones that buyers want to buy exactly equals the quantity that sellers want to sell. To be concrete, suppose the equilibrium price is $2.00 per cone as illustrated in Figure 3.1 below.
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