Supply and Demand and Government Intervention in The Market

Government Intervention
in the Market
Government Intervention in the Market
The Control of
Prices
THE CONTROL OF PRICES
• Equilibrium price and the absence of

shortages and surpluses
• Minimum prices
– justification
– effects
Minimum price: price floor
P
S
Pe
O Q
Minimum price: price floor
P
S
minimum
surplus
price
Pe
O Qd Qs Q
• Minimum prices
– justification
– effects
– dealing with resulting surpluses
Maximum price: price ceiling
P
S
Pe
O Q
Maximum price: price ceiling
P
S
Pe
maximum
price
shortage
O Qs Qd Q
• Minimum prices
– justification
– effects
• Maximum prices
• Minimum prices
– justification
– effects
• Maximum prices
– justification
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
– dealing with resulting shortages
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
– rationing
• Minimum prices
– justification
– effects
• Maximum prices
– justification
– effects
– rationing
– black markets
Effect of price control on black-market prices
P
S
Pe
O Q
P
S
Pe
Pg
O Q
P
S
Pe
Pg
O Qs Qd
Q
P
S
Pb
Pe
Pg
O Qs Qd
Q
P
S
Pb
Pe
Pg
O Qs Qd
Q
Indirect Taxes
INDIRECT TAXES
• Specific and ad valorem taxes

• Effects on supply curve
Effect of a tax on the supply curve
P
O Q
P
S + specific tax
S
amount of
specific tax
O Q
P S + ad valorem tax
O Q
INDIRECT TAXES

• The incidence of taxation
INDIRECT TAXES

– the producers' share
– the consumers' share
Effect of a tax on price and quantity
P
P1
D
O Q1 Q
Effect of a tax on price and quantity
P
S + tax
P1 + tax
S
P2
P1
D
O Q2 Q1 Q
INDIRECT TAXES

• Elasticity and the incidence of taxation

Incidence of tax: inelastic demand
P
S + tax
P1
D
O Q1 Q
P
S + tax
P2
S
P1
D
O Q 2 Q1 Q
P
S + tax
P2
S
CONSUMERS’
SHARE
P1
PRODUCERS’ SHARE
P2 - t
D
O Q 2 Q1 Q
Incidence of tax: elastic demand
P S + tax
P1
D
O Q1 Q
P S + tax
S
P2
P1
D
O Q2 Q1 Q
P S + tax
S
P2
CONSUMERS’
SHARE
P1
D
O Q2 Q1 Q
P S + tax
S
P2
CONSUMERS’
SHARE
P1
PRODUCERS’
D
SHARE
P2 - t
O Q2 Q1 Q
Incidence of tax: inelastic supply
P S + tax
P1
O Q1 Q
P S + tax
P2
P1
O Q2 Q1 Q
P S + tax
P2
P1 CONSUMERS’ SHARE
O Q2 Q1 Q
P S + tax
P2
PRODUCERS’ SHARE
D
P2 - t
O Q2 Q1 Q
Incidence of tax: elastic supply
P S + tax
P1
O Q1 Q
P S + tax
P2
S
P1
O Q2 Q1 Q
P S + tax
P2
S
CONSUMERS’
SHARE
P1
O Q2 Q1 Q
P S + tax
P2
S
CONSUMERS’
SHARE
P1
PRODUCERS’
SHARE
P2 - t
D
O Q2 Q1 Q
P S + tax
P2
PRODUCERS’ SHARE
D
P2 - t
O Q2 Q1 Q
INDIRECT TAXES

• Elasticity and the incidence of taxation

• Implications for tax policy
Government
Rejection of
Market Allocation
GOVERNMENT REJECTION OF MARKET
ALLOCATION
• Providing goods free to consumers
– justification
– effects
– the case of health care
• problems of shortages
The demand for and supply of hospital treatment
P
S
P0 D
Qs shortage Qd Q
The demand for and supply of hospital treatment
P
S
Pe
P0 D
Qs shortage Qd Q
ALLOCATION
– justification
– effects
• methods of dealing with shortages
ALLOCATION
– justification
– effects
• Making products illegal
ALLOCATION
– justification
– effects
– justification
ALLOCATION
– justification
– effects
– justification
– the market for illegal products
ALLOCATION
– justification
– effects
– justification
• comparison with legal prices
The market for an illegal drug
P
Slegal
Plegal
Dlegal
O Qlegal Q
P Sillegal Slegal
Plegal
Dlegal
O Qlegal Q
P Sillegal Slegal
Plegal
Dillegal Dlegal
O Qlegal Q
P Sillegal Slegal
Pillegal
Plegal
Dillegal Dlegal
O Qillegal Qlegal Q
ALLOCATION
– justification
– effects
– justification
– comparison of prohibition and taxation
ALLOCATION
– justification
– effects
– justification
• effects on demand and supply
ALLOCATION
– justification
– effects
– justification
• effects on demand and supply
• effects on price
Agriculture and
Agricultural Policy
AGRICULTURE AND AGRICULTURAL POLICY
• Why governments intervene in

agriculture
– to reduce price fluctuations
– to raise farm incomes
– to protect rural communities
– to encourage greater self-sufficiency in food
• Causes of short-term price fluctuations
– fluctuations in the harvest
– low price elasticity of demand
Elasticities of demand for various foodstuffs (UK)
Source: National Food Survey 2000 (National Statistics, 2001), extracted from Tables 6.1, 6.3, 6.4 and 6.5
Inelastic demand for food
P Sa
1
P1
O Q
Inelastic demand for food
P Sa Sa
1 2
P1
P2
O Q
• Why governments intervene in agriculture

• Causes of declining farm incomes

– low income elasticity of demand

– low income elasticity of demand
– increases in supply
Yields of selected crops (100 kg/hectare)
Source: Agriculture in the European Union, European Economy (European Commission)

Decline in food prices over time
P S1
P1
D1
O Q1 Q
Decline in food prices over time
P S1
S2
P1
P2
D1 D2
O Q1 Q2 Q
• Types of government intervention in

agriculture
– buffer stocks
– subsidies
– high fixed prices
– reducing supply
– structural policies
• Buffer stocks
– buffer stocks to stabilise prices
Buffer stocks to stabilise prices
P
Pg
O Qd Q
P Sa
1
Pg
Bought into buffer stock
O Qd Qs Q
1
P Sa
2
Pg
Released from buffer stock
O Qs Qd Q
2
• Types of government intervention in

agriculture
– buffer stocks
– subsidies
– high fixed prices
– reducing supply
– structural policies
• Buffer stocks
– buffer stocks to stabilise prices
– buffer stocks to stabilise farm incomes
Buffer stocks to stabilise incomes
P
P1 a
O Q
P
Pεd = −1
P1 a
O Q
P Sa Sa
1 2
P1 a
O Q1 Q2 Q
P Sa Sa
1 2
P1 a
Y
P2
D
O Q1 Q2 Q
P Sa Sa
1 2
Bought into buffer stock
P1 a
b
P2′ c Y
P2
D
O Q1 Q2′ Q2 Q
P Sa Sa
3 1
P1 a
O Q3 Q1 Q
P Sa Sa
3 1
P3
P1 a
O Q3 Q1 Q
P Sa Sa
3 1
Released from buffer stock
P3
e d
P3′
P1 a
O Q3 Q3′ Q1 Q
• Subsidies
– effects on price and output
– the incidence of a subsidy
Effect of subsidies on foodstuffs in which the country is self-sufficient
P
S
Pe
O Qe Q
P
S
S + subsidy
Pe
O Qe Q
P
S
S + subsidy
Pe
Pm
O Qe Q1 Q
P
S
S + subsidy
Pg
Subsidy
Pe
Pm
O Qe Q1 Q
P
S
S + subsidy
Pg
Subsidy
Pe
Pm
O Qe Q1 Q
Effect of subsidies on foodstuffs which are partly imported
P
Sdomestic
Pw
Sworld
O Q
P
Sdomestic
Pw
Sworld
O QS1 Qd Q
Imports
P
Sdomestic
S + subsidy
Pw
Sworld
O QS1 QS2 Qd Q
Imports
P
Sdomestic
S + subsidy
Pg
Pw
Sworld
O QS1 QS2 Qd Q
P
Sdomestic
S + subsidy
Pg
Pw
Sworld
O QS1 QS2 Qd Q
• Subsidies
• High minimum prices
• Subsidies
– foodstuffs where the country is a net importer
Minimum price where some of the product is imported
P EU supply
Pw
EU demand
O QS1 Qd1 Q
Imports
P EU supply
Import levy
Pt
Pw
EU demand
O QS1 Qd1 Q
P EU supply
Import levy
Pt AMOUNT PAID
IN IMPORT
LEVIES
Pw
EU demand
O QS1 QS
2
Qd2 Qd Q
1
Imports
• Subsidies
– foodstuffs where the country is self-sufficient
Minimum prices for a product where the EU is self-sufficient
P
SEU
a b
Pw
DEU
O Qd1 QS1 Q
Exports
Minimum prices for a product where the EU is self-sufficient
P
Intervention price SEU
e d
Pi
NET COST
f a b c
Pw
COST
REVENUE FROM
SALE OF SURPLUS
ON WORLD MARKET
DEU
O Qd2 Qd1 QS1 QS2 Q

Surplus
• Subsidies
• Reductions in supply
• Subsidies
– quotas
• Subsidies
– quotas
– taking land out of use (e.g. set aside)
• Justification of the CAP

– assured supplies of food
– support for farm incomes
– growth in agricultural productivity
– stable agricultural prices
– reasonable prices for consumers.

The cost of price and other market support for
agriculture in the EU

• Criticisms of the CAP

– agricultural surpluses
• static costs
The cost to the taxpayer of high fixed prices
P
S
Pe
O Q
P
S
a b
Pi
Pe
O Qd Qs Q
Surplus
P
S
a b
Pi
Pe COST TO
THE
TAXPAYER
D
d c
O Qd Qs Q
Surplus
The cost to the taxpayer of subsidies
P
S
a
Pf
Pe Subsidy
b
Pc
D
O Q1 Q2 Q
The cost to the taxpayer of subsidies
P
S
a
Pf
COST TO
Pe THE TAXPAYER
b
Pc
D
O Q1 Q2 Q
Unequal support given to different agricultural
products in the EU: 2001

Unequal support given to different agricultural
products in the EU: 2001

• Criticisms of the CAP (cont.)

– irrational relative prices
– removes disciplines of markets
– redistributive effects
– effects on the environment
– effects on the rest of the world
• effects of import levies
• effects of export subsidies
• Reforming the CAP

– price reductions
– production quotas
– set aside
– diversification; low-intensity farming
– income support
– the MacSharry reforms
• effects on surpluses
Effect of the MacSharry reforms on cereal surpluses
P
S1
a b
P1
FARMERS'
ORIGINAL INCOME
d c D
O Qd1 Qs1 Q
Original surplus
P Reduction in
intervention S1
price
a b
P1
P2
d c D
O Qd1 Qs1 Q
P S2
S1
a b
P1
P2
Effect of
Set-aside
d c D
O Qd1 Qs1 Q
P S2
S1
a b
P1
a′ b′
P2
FARMERS'
REDUCED
INCOME
d c′ c D
O Qd1 Qd2 Qs Qs1 Q
2
Reduced surplus

– set aside
– income support
• continuing problems

– set aside
– income support
– Agenda 2000

– set aside
– income support
– Agenda 2000
• the issue of EU enlargement

– set aside
– income support
– Agenda 2000
• proposals

– set aside
– income support
– Agenda 2000
• proposals
• subsequent events

– set aside
– income support
– Agenda 2000
• proposals
• subsequent events
– The 2002 reform proposals

Supply and Demand and Government Intervention in The Market

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Supply and Demand and Government Intervention in The Market

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Government Intervention

• Equilibrium price and the absence of

• Specific and ad valorem taxes

• Specific and ad valorem taxes

• Specific and ad valorem taxes

• Specific and ad valorem taxes

• Elasticity and the incidence of taxation

• Specific and ad valorem taxes

• Elasticity and the incidence of taxation

• Why governments intervene in

• Why governments intervene in agriculture

• Why governments intervene in agriculture

• Why governments intervene in agriculture

Source: Agriculture in the European Union, European Economy (European Commission)

• Types of government intervention in

Bought into buffer stock

Released from buffer stock

• Types of government intervention in

Bought into buffer stock

Released from buffer stock

O Qd2 Qd1 QS1 QS2 Q

• Justification of the CAP

– support for farm incomes

– growth in agricultural productivity

– stable agricultural prices

– reasonable prices for consumers.

Source: Agriculture in the European Union, European Economy (European Commission)

• Criticisms of the CAP

Source: Agriculture in the European Union, European Economy (European Commission)

Source: Agriculture in the European Union, European Economy (European Commission)

• Criticisms of the CAP (cont.)

• Reforming the CAP

• Reforming the CAP

• Reforming the CAP

• Reforming the CAP

• Reforming the CAP

• Reforming the CAP

• Reforming the CAP

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