Managerial Economics

PGDM : 2019 – 2021

Term 1 (July – September, 2019)
(Lecture 7 and 8)

1
 Topics to Be Covered

• Government Intervention and Market Equilibrium

 Price Ceiling: Rent Control

 Price Floor: Minimum Wage

 Incidence of Tax

• We will use the supply/demand model to see how each

policy affects the market outcome (the price buyers pay, the
price sellers receive, and equilibrium quantity).
 Price control and Market Equilibrium

• Price ceiling: a legal maximum on the price

of a good or service e.g., rent control

• Price floor: a legal minimum on the price of

a good or service e.g., minimum wage

3
 EXAMPLE 1: The Market for Apartments

Rental P S
price of
apts

$800
Eq’m
Eq’m w/o
w/o
price
price controls
controls

D
Q
300
Quantity of
apartments
4
 How Price Ceilings Affect Market Outcomes

A price ceiling P
above the S
Price
eq’m price is $1000
ceiling
not binding –
has no effect $800
on the market
outcome.

D
Q
300

5
 How Price Ceilings Affect Market Outcomes

The eq’m price P S

($800) is above
the ceiling and
therefore illegal.
The ceiling $800
is a binding Price
constraint $500
ceiling
on the price, shortage
causes a shortage. D
Q
250 400

6
 How Price Ceilings Affect Market Outcomes

In the long run, P S

supply and
demand
are more
$800
price-elastic.
So, the shortage Price
$500
is larger. ceiling
shortage
D
Q
150 450

7
 Shortages and Rationing
 With a shortage, sellers must ration the goods
among buyers.
 Some rationing mechanisms: (1) Long lines
(2) Discrimination according to sellers’ biases
 These mechanisms are often unfair, and inefficient:
the goods do not necessarily go to the buyers who
value them most highly.
 In contrast, when prices are not controlled,
the rationing mechanism is efficient (the goods
go to the buyers that value them most highly)
and impersonal (and thus fair).
EXAMPLE 2: The Market for Unskilled Labor

Wage W S
paid to
unskilled
workers
$4
Eq’m
Eq’m w/o
w/o
price
price controls
controls
D
L
500
Quantity of
unskilled workers
9
 How Price Floors Affect Market Outcomes

A price floor W
below the S
eq’m price is
not binding –
has no effect $4
on the market
outcome. Price
$3
floor

D
L
500

10
 How Price Floors Affect Market Outcomes
labor
The eq’m wage ($4) is W surplus S
below the floor and Price
therefore $5
floor
illegal.
The floor $4
is a binding
constraint
on the wage,
causes a D
surplus (i.e., L
400 550
unemployment).

11
 The Minimum Wage
Min wage laws unemp-
do not affect W loyment S
highly skilled Min.
$5
workers. wage

They do affect teen $4

workers.
Studies:
A 10% increase
in the min wage D
raises teen L
400 550
unemployment
by 1-3%.

12
Highlights: Code on Occupational Safety, Health and Working
Conditions (OSH) Bill 2019

•The bill simplifies, amalgamates and rationalises the provisions of 13

central labour laws.
•It expands the ambit of the provisions relating to working conditions of
cine, theatre workers and journalists
•It expands the definition of family to include dependent grandparents
•It allows the women employees to work at night
Highlights: Code on Wages Bill 2019
•The bill simplifies the definition of wages
•It universalises the provisions of minimum wages and timely payment of wages to employees irrespective of
the sector and wage ceiling.
•It seeks to increase the legislative protection of minimum wage to 100 per cent of the workforce
•Minimum wage will be fixed based on geography and skills.
•Updated every 5 years
• The Bill also provides for revising minimum wages every five years and emphasizes on the use of technology for
enforcement, along with payment of wages by cheque or through digital modes.

• The Economic Survey of 2018-19 had highlighted the complexity in the minimum wage system in India by
pointing out that there were nearly 429 scheduled employments and 1,915 scheduled job categories for unskilled
workers across India covered by the Minimum Wages Act of 1948. The bill removes the concept of 'scheduled
employments' - declared as such by the central and state governments.

• Enforcement ?? : The Sixth Economic Census enumerated 3.1 million establishments in the manufacturing sector
alone, which employ at least one hired worker, and 15.23 million in the broad non-agricultural sector. Inclusion of
agriculture will take the total to a massive figure.

• Productivity differences? Estimates?

 A Tax on Sellers
The tax effectively raises Effects of a $1.50 per
unit tax on sellers
sellers’ costs by
P S2
$1.50 per pizza. $11.50
Tax S1
Sellers will supply
500 pizzas
$10.00
only if
P rises to $11.50,
to compensate for
this cost increase. D1

Hence,
Hence, aa tax
tax on
on sellers
sellers shifts
shifts the
the Q
S 500
S curve
curve up
up byby the
the amount
amount ofof the
the tax.
tax.

15
 A Tax on Sellers
New eq’m: Effects of a $1.50 per
unit tax on sellers
Q = 450 P S2
Buyers pay S1
PB = $11.00 PB = $11.00
Tax
Sellers $10.00
receive PS = $9.50
PS = $9.50
D1
Difference
between them
Q
= $1.50 = tax 450 500

16
 A Tax on Buyers
The
Hence,priceaabuyers
Hence, tax onpay
tax on buyers
buyers Effects of a $1.50 per
is nowthe
shifts
shifts $1.50
the D higher
D curve than the
curve down
down unit tax on buyers
market
by
by the price
the amount
amount P. of
of the tax. P
the tax.
P would have to fall S1
by $1.50 to make
buyers willing $10.00
Tax
to buy same Q
as before.
$8.50
E.g., if P falls D1
from $10.00 to $8.50,
D2
buyers still willing to
Q
purchase 500 pizzas. 500

17
 A Tax on Buyers
New eq’m: Effects of a $1.50 per
unit tax on buyers
Q = 450 P
Sellers S1
receive PB = $11.00
Tax
PS = $9.50 $10.00
Buyers pay PS = $9.50
PB = $11.00
D1
Difference
between them D2
Q
= $1.50 = tax 450 500

18
The Incidence of a Tax:
how the burden of a tax is shared among
market participants
P
In our
S1
example, PB = $11.00
Tax
buyers pay $10.00
$1.00 more, PS = $9.50
sellers get
$0.50 less. D1
D2
Q
450 500

19
 The Outcome Is the Same in Both Cases!
The effects on P and Q, and the tax incidence are the
same whether the tax is imposed on buyers or sellers!
What matters P
is this: S1
PB = $11.00
A tax drives Tax
a wedge $10.00
between the PS = $9.50
price buyers
pay and the D1
price sellers
receive. Q
450 500

20
 Elasticity and Tax Incidence
CASE 1: Supply is more elastic than demand

P It’s
It’s easier
easier
for
for sellers
sellers
PB S than
than buyers
buyers
Buyers’ share
of tax burden
to
to leave
leave the
the
Tax market.
market.
Price if no tax So
So buyers
buyers
Sellers’ share bear
bear most
most ofof
PS
of tax burden the
the burden
burden
of
of the
the tax.
tax.
D
Q

21
 Elasticity and Tax Incidence
CASE 2: Demand is more elastic than supply

P It’s
It’s easier
easier
S for
for buyers
buyers
Buyers’ share than
than sellers
sellers
of tax burden PB to
to leave
leave thethe
market.
market.
Price if no tax
Tax Sellers
Sellers bear
bear
Sellers’ share most
most of of the
the
of tax burden PS burden
burden of of
D the
the tax.
tax.
Q

22
 CASE STUDY: Who Pays the Luxury Tax?
The market for yachts Demand
Demand is is
price-elastic.
price-elastic.
P
S
In
In the
the short
short run,
run,
Buyers’ share
of tax burden PB supply
supply is
is inelastic.
inelastic.

Tax Hence,
Hence,
companies
companies
Sellers’ share
that
that build
build
of tax burden PS
D yachts
yachts pay
pay
most
most ofof
Q the
the tax.
tax.

23
PROBLEMS

Price per frisbee Quantity Demanded Quantity Supplied

12 140 20
20 100 100

a) Derive the demand curve and supply curve for frisbees. ( Use point slope formula as ( x1, y1) and ( x2, y2) are
given. Find the eqlbm quantity and price.

b) What is the price elasticity of demand? What is the price elasticity of supply? ( At eqlbm)

c) Suppose a tax is levied on the purchase of frisbees? Does it matter whether it is levied of buyers or sellers? Who is
impacted more by the imposition of tax – buyers or sellers?
 SUGGESTED READINGS

https://www.forbes.com/sites/jonhartley/2016/05/31/indias-price-ceiling-on-uber-rides-hurts-riders-drivers-and-the-econ
omy/#7d7474892e0e

( Price Ceiling Uber)

https://www.businesstoday.in/opinion/columns/code-on-wages-bill-2019-universal-minimum-wage-enforced-organised-s
ector-workers-unorganised-workforce/story/367641.html

(Minimum Wage Law)

https://www.indianeconomy.net/splclassroom/what-is-minimum-support-price/

( What is Minimum Support Price)