Economics 1A
COECA1
Week 3: Lesson 2
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Eduvos and the Flipped Classroom
1 2 3
Before this lecturer-led session During this lecturer-led session After this lecturer-led session
At home, in your self-study time, you During your lecturer-led session(s), you will Depending on how difficult this lecturer-led
worked through myLMS content to prepare engage with your peers and lecturer in session is, your lecturer may recommend
you for this lecturer-led session. You have active learning. I.e. you will have an some concepts to revise for this week's
completed any practice activities and opportunity to ask your questions, to learning opportunities. Then you will focus
prepared any questions you may still have debate topics, and to practice working on the following learning opportunities on
on the content. The lecturer-led session will through the technical aspects of what you myLMS in your self-study time to prepare
not be a traditional lecture. learnt at home. You will be exposed to for the next lecturer-led session(s).
higher-order thinking activities. Your
lecturer will guide you on what to prepare
before attending your next session.
Opening Quiz
1. Which of the following is NOT a reason why governments intervene in markets?
a) To correct market failures
b) To ensure fair competition
c) To maximize profits for private businesses
d) To protect consumers and the environment
2. What is a common tool governments use to control the prices of goods and services?
a) Subsidies
b) Price controls (ceilings and floors)
c) Taxes
d) Advertising 1.C, 2.B, 3.B, 4.B
3. Which of the following is an example of a price ceiling?
a) Minimum wage law
b) Rent control in urban areas
c) Government subsidy for farmers
d) Import tax on goods
[Link] a government provides financial support to a business to reduce costs and encourage production, it is called:
a) Taxation
b) Subsidy
c) Price ceiling
d) Deregulation
What will be covered in the rest of today’s session?
What will be covered in the lecture-led session:
• Differentiate between price ceilings and price floors
• Explain how housing markets and labour markets function, and how these
markets may cause economic inefficiencies.
• Explain how taxes cause economic inefficiencies
• Explain how the elasticity of demand and supply influence the overall tax
incidence on buyers and sellers
A Housing Market with a Rent Ceiling
• Government regulation that makes it illegal to charge a price higher than a specified level is called a
price ceiling or price cap
• The effect of a price (rent) ceiling depends on whether it is imposed at a level that is above or below
the equilibrium price (rent).
• A price ceiling set above the equilibrium price has no effect.
• The reason is that the price ceiling does not constrain the market forces.
• The force of the law and market forces are not in conflict. But a price ceiling below the equilibrium price
has powerful effects on a market
• The reason is that the price ceiling attempts to prevent the price from regulating the quantities
demanded and supplied.
The force of the law and market forces are in conflict
A Housing Market with a Rent Ceiling-
continued
• A price ceiling is a regulation that makes it illegal to
charge a price higher than a specified level
• When a price ceiling is applied to housing markets, it is
called a rent ceiling
• A price ceiling set above the equilibrium price has no
effect
• A price ceiling below the equilibrium price has
powerful effects on a market
FIGURE 6.1
A Housing Market with a Rent
Ceiling
When a rent ceiling creates a housing shortage, two developments occur:
search activity and black markets
• The time spent looking for someone with whom to do business is called search activity
• When a price is regulated and there is a shortage, search activity increases
• The opportunity cost of a good is equal not only to its price but also to the value of the
search time spent finding the good
• A black market is an illegal parallel market in which the price exceeds the legally
imposed price ceiling
• The level of a black-market rent depends on how tightly the rent ceiling is enforced
• With loose enforcement, the black-market rent is close to the unregulated rent
A Housing Market with a Rent
Ceiling
• In an unregulated market, the market determines the
rent at which the quantity demanded equals the
quantity supplied
• In this situation, scarce resources are allocated
efficiently
• Marginal social benefit equals marginal social cost
(market demand equals market supply)
• According to the fair rules view, anything that blocks
voluntary exchange is unfair, so rent ceilings are
unfair
• According to the fair result view, a fair outcome is
one that benefits the less well off and allocates
resources to the poorest
FIGURE 6.2
A Labour Market with a Minimum
Wage
• A price floor is a regulation that makes it illegal
to trade at a price lower than a specified level
• When a price floor is applied to labour markets,
it is called a minimum wage
• If a minimum wage is set below the equilibrium
wage, the minimum wage has no effect
• If a minimum wage is set above the equilibrium
wage, the minimum wage is in conflict with
market forces and does have some effects on
the labour market
• A wage below R10 an hour is illegal (in the grey-shaded
illegal region).
FIGURE 6.3 • At the minimum wage of R10 an hour, 20 million hours
are hired but 22 million hours are available.
• Unemployment – AB – of 2 million hours a year is
created
A Labour Market with a Minimum
Wage
• In an unregulated labour market, everyone who is
willing to work for the going wage rate gets a job
and the market allocates the economy’s scarce
labour resources accordingly
• The minimum wage frustrates the market
mechanism and results in unemployment – wasted
labour resources – and an inefficient amount of job
search
• In the labour market, the supply curve measures
the marginal social cost of labour to workers
• The demand curve measures the marginal social
benefit from labour
• This benefit is the value of the goods and services
produced
• There is a deadweight loss because at the quantity of
labour employed – 20 million hours – the value to the
firm of the marginal worker exceeds that wage rate for
which that person is willing to work. ( its expensive for
the firm to employ extra worker)
• At this level of employment, unemployed people have a
big incentive to spend time and effort looking for work.
• The red rectangle shows the potential loss from this
FIGURE 6.4 extra
job search
• This loss arises because someone who finds a job
earns R10 an hour (read off from the demand curve)
but would have been willing to work for R6 an hour
(read off from the supply curve),
• A minimum wage shrinks the firms’ surplus (blue
triangle) and workers’ surplus (green triangle) and
creates a deadweight loss (grey triangle).
Critical thinking questions
[Link] are the long-term effects of rent control (a price
ceiling) on the housing market?
[Link] there situations where price ceilings and floors are
necessary for social welfare? Provide examples
ANSWERS
1. · Black Markets: Informal or illegal rental agreements may emerge, where tenants pay extra under the table.
· Inefficient Allocation: Rent-controlled apartments might be occupied by tenants who do not need them as much as
others, leading to a mismatch between supply and demand.
· Reduced Mobility: Tenants may stay in units longer than needed because of low rent, limiting housing availability for
others.
2. · Price Ceilings:
• Essential Goods: During crises (e.g., natural disasters), price ceilings can prevent price gouging for food, water, and
fuel.
• Healthcare: Capping drug prices can ensure life-saving medicine remains accessible.
• Housing: Temporary rent controls in rapidly gentrifying areas can protect vulnerable residents.
· Price Floors:
• Minimum Wage: Ensures workers earn a liveable income and reduces poverty.
• Agriculture: Supports farmers in developing countries against price volatility.
Taxes on Sellers and Buyers
• Personal income taxes are deducted from your earnings and value-added
taxes are added to the bill when you buy something
• Tax Incidence
• Tax incidence is the division of the burden of a tax between the
buyer and the seller
• A Tax on Sellers
• In Figure 6.6, the demand curve is D, and the supply curve
is S
• A tax on sellers is like an increase in cost, so it decreases supply
• To determine the position of the new supply curve, we add the tax to the
minimum price that sellers are willing to accept for each quantity sold
• Equilibrium occurs where the new supply curve intersects the demand curve
TAXES
• You can see that without the tax, sellers are willing to
offer 350 million packs a year for R20 a pack.
• So with a R15 tax, they will offer 350 million packs a year
only if the price is R35 a pack.
• The supply curve shifts to the red curve labelled S + tax
on sellers.
• Equilibrium occurs where the new supply curve
intersects
the demand curve at 325 million packs a year.
• The price paid by buyers rises by R10 to R30 a pack.
And the price received by sellers falls by R5 to R15 a
pack. So buyers pay R10 of the tax and sellers
pay the other R5
TAXES
A Tax on Buyers
• A tax on buyers lowers the amount they are willing to pay the
seller, so it decreases demand and shifts the demand curve
leftward
• To determine the position of this new demand curve, we
subtract the tax from the maximum price that buyers are
willing to pay for each quantity bought
Equivalence of Tax on Buyers and Sellers
Value-Added Tax
• Value-added tax is an example of a tax that the government
imposes equally on both buyers and sellers
• The division of the burden of a tax between buyers and sellers
depends on the elasticities of demand and supply
TAX ON A tax on buyers of R15 a pack shifts the demand curve
leftward to D – tax on buyers.
BUYERS The equilibrium quantity decreases to 325 million packs a
year, the price paid by buyers rises to R30 a pack and the
price received by sellers falls to R15 a pack.
The tax raises the price paid by buyers by less than the
tax and lowers the price received by sellers, so buyers and
sellers share the burden of the tax.
Tax Division and Elasticity of Demand
• Tax Division and Elasticity of Demand
• The division of the tax between buyers and sellers depends in part on the price
elasticity of demand
• Perfectly price inelastic demand – buyers pay
• Perfectly price elastic demand – sellers pay
Tax Division and Elasticity of Demand
• Part (a) shows the market for insulin, where demand is perfectly price
inelastic.
• With no tax, the price is R200 a dose and the quantity is 100 000 doses a
day. A tax of R20 a dose shifts the supply curve to S + tax. The price
rises to R220 a dose, but the quantity bought does not change.
• Buyers pay the entire tax.
• Part (b) shows the market for pink pens, in which demand is perfectly
price elastic.
• With no tax, the price of a pen is R20 and the quantity is 4
000 pens a week.
• A tax of R2 a pink pen shifts the supply curve to S + tax.
• The price remains at R20 a pen, and the quantity of pink pens sold
decreases to1 000 a week. Sellers pay the entire tax.
Tax Division and Elasticity of Supply
• The division of the tax between buyers and sellers also
depends, in part, on the price elasticity of supply
• Perfectly price inelastic supply – sellers pay
• Perfectly price elastic supply – buyers pay
• Perfect price elastic supply - High responsiveness of quantity supplied to changes in
price
• Perfectly price elastic supply – buyers pay
• Perfectly price inelastic - this indicates a low responsiveness of the firm to price increases
• Perfectly price inelastic supply – sellers pay
TAXES
Tax Division and Elasticity of Supply
Taxes and Efficiency
• Taxes and Efficiency
• The price buyers pay is also the buyers’ willingness to pay,
which measures marginal benefit
• Taxes and Fairness
• The Benefits Principle
• The benefits principle is the proposition that people should pay taxes equal to
the benefits they receive from the services provided by government
• The Ability-to-Pay Principle
• The ability-to-pay principle is the proposition that people should pay taxes
according to how easily they can bear the burden of the tax
The Benefits Principle
• The benefits principle can justify high fuel taxes to pay for freeways,
• high taxes on alcoholic beverages and tobacco products to pay for public health-care
services,
• high rates of income tax on high incomes to pay for the benefits from law and order
and from
• living in a secure environment, from which the rich
• might benefit more than the poor.
The Ability-to- Pay Principle
• A rich person can more easily bear the burden than a poor person can, so the
ability-to-pay principle
• can reinforce the benefits principle to justify high rates of income tax on
high incomes
TAXES
• With no tax on DVD players, 5 000 a week are bought and sold
at R1000 each.
• With a tax of R100 a DVD player, the buyers’ price rises to
R1050 a player, the sellers’ price falls
• To R950 a player and the quantity decreases to 4 000 DVD
players a week.
• Consumer surplus shrinks to the green triangle and the producer
surplus shrinks to the blue triangle
• Part of the loss of total surplus (the sum of consumer surplus
and producer surplus) goes to the government as tax
revenue, the purple rectangle, and a deadweight loss arises,
the grey triangle
Subsidies and Quotas
• Subsidies
• A subsidy is a payment made by the
government to a producer
• Production Quotas
• A production quota is an upper limit to the
quantity of a good that may be produced in a
specified period
The effects of a subsidy
• The effects of a subsidy are similar to the effects of a tax but they go in the opposite directions
• These effects are:
❖an increase in supply
❖a fall in price and increase in quantity produced
❖an increase in marginal cost
❖payments by government to farmers
❖inefficient overproduction
Production Quota
• But a production quota set below the equilibrium quantity has big
effects, which are:
◆ a decrease in supply
◆ a rise in price
◆ a decrease in marginal cost
◆ inefficient underproduction
◆ an incentive to cheat and overproduce
• Figure 6.9 • Figure 6.10
• With no quota, growers produce 60 million tonnes a • With no subsidy, farmers produce 40 million tons a
year and the price is R300 a tonne year at R1 400 a tonne
• A production quota of 40 million tonnes a year restricts • A subsidy of R200 a tonne shifts the supply curve
total production to that amount rightward to S – subsidy.
• The quantity produced decreases to 40 million tons a • The equilibrium quantity increases to 60 million
year, the price rises to R500 a tonne, and the farmers’ tonnes a year, the price falls to R1 300 a
marginal cost falls to R200 a tonne
tonne, and the price plus the subsidy received
• Because marginal social cost (on the supply curve) is by farmers rises to R1 500 a tonne.
less than marginal social benefit (on the demand
curve), a deadweight loss arises from the • In the new equilibrium, marginal social cost (on the
underproduction supply curve) exceeds marginal social benefit (on
the demand curve) and the subsidy results in
inefficient overproduction
Markets for Illegal Goods
A Market for an Illegal Drug
• When a good is illegal, the cost of trading in the good increases
Penalties on Sellers
• Drug dealers in South Africa face large penalties if their activities are detected
• These penalties are part of the cost of supplying illegal drugs,
and they bring a decrease in supply – a leftward shift in the
supply curve
Penalties on Buyers
• Penalties fall on buyers, and the cost of breaking the law must be subtracted from the value of the good to
determine the maximum price buyers are willing to pay for the drugs
Penalties on Both Sellers and Buyers
• If penalties are imposed on both sellers and buyers, both supply and demand decrease
• The larger the penalties and the greater the degree of law enforcement, the larger is the decrease in
demand and/or supply
Questions to discuss
With the aid
Define a of diagrams
ce ceiling illustrate
nd a price When When the
Why are who bear When the
floor. demand is supply
government the burden demand
laborate perfectly curve is
hen these regulations of a tax in curve is
perfectly
two inefficient? the inelastic. elastic
inelastic
gulations following
e bidding circumstan
ces
What Happens Next?
•Prepare Chapter 8 ( Demand and
Utility on MyLMS)
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Bibliography
Thompson, K.L., Scholtz, F. & Schoer, V. (2018). Economics: Global & Southern African Perspective. 3rd ed. Pearson.
