Scribd
Upload
20 views

Application of Supply and Demand

Applied economics

Uploaded by

Joan Dardo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
20 views

Application of Supply and Demand

Applied economics

Uploaded by

Joan Dardo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 3

APPLICATION OF SUPPLY AND DEMAND

OBJECTIVE: Define application of supply and demand


The analysis of price determination in terms of demand and supply is not merely of great theoretical significance
but it has important several practical application in economic life of a country.
Demand and supply is also used to explain the implications of price control and rationing, minimum price fixation,
incidence of taxes, and other several economic problem.
The market mechanism is allowed to function without interferes by the government. But government in the
modern mixed economies interferes with the functioning of the market system to influence prices to promote social
welfare when it is felt that free working of market will not produce desirable results.
The government can interfere in two ways:
1. Fixes the maximum price (often called price ceiling)
- Price controls of food-grains, rent control are the example of fixation of maximum price above which the seller
cannot change the price.
2. Working through the market
- Impose taxes on the commodities or provide subsidies. These taxes and subsidies affect the market supply
or demand curves which determine prices of grade services.
Price Control and Rationing
- Price control is quite common and was introduced by several countries during the Second World War.
- I is a way to help the poor against inflation.

KEYWORD: Revenue is the amount of money


that is brought into a company by its business
activities.
FIGURE 1 FIGURE 2

Black Market
- By black market we mean the sale of a commodity by the producer or sellers at a price higher than the
controlled price.
- Some buyer of the commodity will not be fully satisfied as they will not be able to get the quantity of the good
they wish to buy at the controlled price.
- Therefore, they will be prepared to pay a higher price for getting more quantity of the good they will be
prepared to pay a higher price for getting more quantity of the good, but they can do so only in the black
market.
Rent Control
 Rent control are another example of maximum price that government fixes on the rental price of housing
units.
 The maximum rent fixed by the government helps the tenants who generally belong to lower and middle
income groups and intend to prevent their exploitation by rich landlords who would charge a very high market
determined rates of rent
 However, it is important to understand both the short run and long run effects of rent control.
- The long run effect of rent control is different from the short run. In the short run the landlords have
almost a fixed number of housing units/ departments to give on rent. On the other hand, people
searching for rental housing units are also not very responsive in the short run as it always takes time
for them to adjust their housing arrangements.

Figure3: Effect of rent control in the short run. Figure 4: Effect of rent control in the long run.

Minimum Support Price


- For many agricultural products the government policy has been to fix a price floor that is the minimum support
price above the equilibrium level which is considered to be low and un-remunerative to the farmers.
- While in case of price control of fixation of price ceiling the government simply announces the maximum price
above which price cannot be charged by the producers of sellers of a product, in case of minimum support
price, the government becomes an active buyer of the product in the market.
Figure 5: Minimum support price for agriculture.

Important Result of Price Support Policy


1. Price paid by the consumers who buy from the open market increases when the minimum support price of the
agricultural product is fixed at a higher level than the equilibrium price. This is because supply of the agricultural
product in the open market decreases as a result of Government purchases of it from the farmers.
2. Fixation of minimum support price (i.e., price floor) leads to the emergence of wheat surplus which the
Government has to purchase from the farmers. This is quite obvious from the Indian experience where fixation of
higher minimum support price (MSP) has resulted in mountain of food grains with Food Corporation of India.
3. Taxpayers pay more tax money to finance the Government's wheat purchases as well as storage costs.
4. How to dispose of the surplus purchased from the farmers poses a big problem. There are several ways to
dispose of the surplus procured. One way is to sell it at subsidized rate to the persons below the poverty line
through public distribution system. Second, the surplus can be used to make a part payment of wages in terms of
food-grains under 'food for work' programme. Third, food surplus can be given to other countries as foreign aid or
it can be exported.
5. Incomes of the farmers increase as a result of minimum support price fixed at a higher level than the free market
equilibrium price. As a result of price support, they receive higher price than that which would prevail in the free
market and also they produce and sell more than before. They sell a part of their larger production in the market
and a part to the Government.
Monopolistic Competition
- It describes common market structure in which firms have many competitors, but each one sells a slightly
different products.
Characteristics of monopolistic competitive markets:
 Cost of production
 Knowledge
 The entrepreneur
 Barriers to entry
 Products are differentiated
 Firms are price makes and are faced with a downward sloping demand curve.
 Firms operating under monopolistic competition usually have to engage in advertising.
 Monopolistically competitive firms are assumed to be profit maximizers because firms tend to be small with
entrepreneurs actively involved in managing the business.
 There are usually a large numbers of independent firms competing in the market.
Incidence of Indirect Taxes
- A significant application of demand supply model is that it explains the problem of incidence of indirect taxes
such as sales tax and excise duty on commodities.
Example: if sale tax is imposed on a commodity the question is whether the producers will bear the burden of the
tax or the consumers who buy the commodity of the money of the sales tax would be distributed in some ways
between the producers and there consumers.

Figure 6: Incidence of tax.

Figure 7: Incidence of tax in case of perfectly inelastic demand.

Figure 8: Incidence of tax in case of perfectly elastic demand.

Figure 9: Incidence of an indirect tax in case of elastic and inelastic demand

You might also like