Unit 1.

1:

Demand & Supply

Theoretical foundations & practical
application
(Chapter 2)

Outcomes
Revise the concepts of demand, supply
surplus and shortages as well as demand
and supply curves.
Calculate equilibrium price and quantity
given the demand and supply functions.
IIlustrate and explain the effect of tax on
the consumer price, producer price, dead
weight loss and government income given
different elasticities

Market: Demand & Supply

Market: consists of buyers

and sellers of a good or
service
Law of demand: P
Law of supply: P

Qd
Qs

in supply:
1. Prices of relevant inputs
2. Technology
3. Number of sellers
4. Expectations of future
prices
5. Weather/ Government

in demand:
1. Income:
Normal product: Y
D
Inferior product: Y
D
2.
3.

4.
5.

Preferences / Tastes
Prices of related products
Substitute: Px Vy
Compliments: Px Vy
Number of buyers
Expectations of future
prices

Supply & Demand: Shortages &

Surpluses
Surplus: condition in the
market where Qs > Qd.

surplus

P1

Downward pressure on price

Shortage: condition in the

market where Qd > Qs

Pe

Upward pressure on price

P2
D

shortage
Q1

Qe

Q2

Consumers & producers surplus

Consumer surplus: difference between the max price a
buyer is willing an able to pay and the prices actually
paid
Producer surplus: difference between the price sellers
receive and the minimum price for which they would
have sold the good
The more consumers (producers) surplus that buyers
(sellers) receive, the better off they are.
At equilibrium the sum of consumers and producers
surplus is maximized!

Price controls
Price ceiling: a government-mandated maximum price
above which legal trades cannot be made.
Effects:

Shortage
Fewer exchange
Non price rationing device
Buying and selling at prohibited price
Tie-in sales

Price floor: is a government-imposed limit on how low a

price can be charged for a product.
To be effective = price floor must be greater than equilibrium
price.
Effects:
Creates a surplus
Fewer exchange

Tax incidence

Tax incidence depends on

2 factors;
1. Market structure (perfect
competition vs monopoly)
2. Elasticity of supply and
demand

Tax incidence: Who bears the

tax incidence?
Focus not on income tax tax
on products!!!

Difference:
Statutary incidence: refers
to the legal responsibility to
pay tax to SARS.
Economic incidence: refers
to who really bears the tax
Yd decreases (how Tax
influence prices)

Economists are interested

in:
1. Who bears the tax burden?
2. What is the impact on
government revenue?
3. What is the size of the deadweight loss?

Figure 2.16: Tax imposed on

consumer and producer

Degree of elasticity, incidence,

dead weight loss and tax income
Elasticity influences:
- the degree of incidence (and T-burden)maximised on consumer when demand is inelastic.

- T-income- maximised when demand curve is inelastic.

- The size of the dead weight loss- greater when
the demand curve is elastic

Refer to additional notes on BB for detailed

explanation.

Figure 2.15: Elasticity & tax

incidence

Also see additional notes on BB

Summary:
T-incidence maximized on inelastic curve
Government income maximized on
inelastic curve
Dead weight loss larger if curve is elastic!