APPLIED III

ECONOMICS
Supply, Demand and Government
Policies

ATENEO DE ZAMBOANGA UNIVERSITY

SENIOR HIGH SCHOOL
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 CONTENTS
Lesson Demand and Supply Equation
Linear Demand Equation
Linear Supply Equation
Solving for the Equilibrium Price and Quantity

Lesson Effect of Government Policies

Price Ceiling
Price Floor
Taxes
Case Study: Taal Volcano Eruption and N95 Masks

Lesson Market Structures

Market Structures
Monopoly
Oligopoly
Monopolistic Competition
Perfect Competition

Quizzer
SUPPLY, DEMAND, AND GOVERNMENT POLICIES MODULE 3

LESSON 8: Demand and Supply Equation

S upply and demand are the two words that economists use most often—and for good reason. Supply and
demand are the forces that make market economies work. They determine the quantity of each good
produced and the price at which it is sold. If you want to know how any event or policy will affect the
economy, you must think first about how it will affect supply and demand.

LINEAR DEMAND EQUATION

The demand curve shows the quantity of goods consumers are willing to buy at each market price. A
linear demand curve can be plotted using the following equation.

Qd = a – b(P)
Qd = quantity demand
a = all factors affecting price other than price (e.g. income)/ Autonomous Demand (Qd when P= 0)
b = inverse slope of the demand curve/ Price coefficient of demand
P = Price of the good.

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Price coefficient is the amount by which quantity demanded will fall for every ₱1.00 increase in price.
Take note that the price coefficient is always negative as it indicates decrease in quantity demanded. To
compute for the price coefficient, use the inverse of a slope formula.

𝑟𝑖𝑠𝑒 𝑟𝑢𝑛 𝑄1−𝑄0

𝑆𝑙𝑜𝑝𝑒 = 𝐼𝑛𝑣𝑒𝑟𝑠𝑒 𝑜𝑓 𝑆𝑙𝑜𝑝𝑒 = 𝑃𝑟𝑖𝑐𝑒 𝐶𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 =
𝑟𝑢𝑛 𝑟𝑖𝑠𝑒 𝑃1−𝑃0

Autonomous demand is quantity being demanded when income equals zero. It can be computed only
after computing for the price coefficient. To solve for autonomous demand, first substitute the price
coefficient in the demand equation. Afterwards, select a point in the demand curve, then substitute the
price and quantity demanded of that point into the demand equation. After which, you may already
compute for the autonomous demand by means of algebra.

Price intercept of demand is the price at which consumers are willing and able to purchase a good. This
can be computed by substituting the quantity demanded by zero. Graphically, this is the point where the
demand curve begins.

Change in autonomous demand and price coefficient

In the event a change in determinants of demand, aside from price, occurs, this will indicate either an
increase or decrease in the demand in total. It reflects either a shift in the demand curve to the right or
to the left. Thus, in the demand equation, the net effect of the change is either added or subtracted to
the autonomous demand.

In the event a change in the price coefficient occurs, a change in the steepness of the curve will occur.
Subsequently, this will cause the demand curve to change from inelastic to elastic and vice versa or
become more elastic or more inelastic.

LINEAR SUPPLY EQUATION

The supply curve shows the quantity of goods firms are willing to supply at each market price. A linear
supply curve can be plotted using the following equation.

Qs = c – d(P)
Qs = quantity supplied
c = quantity intercept (point at which the supply curve meets the quantity axis)
b = inverse slope of the supply curve/ Price coefficient of supply
P = Price of the good.

Price coefficient is the amount by which quantity supplied will fall for every ₱1.00 increase in price. Take
note that the price coefficient is always negative as it indicates decrease in quantity demanded. To
compute for the price coefficient, use the inverse of a slope formula.

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𝑟𝑖𝑠𝑒 𝑟𝑢𝑛 𝑄1−𝑄0

𝑆𝑙𝑜𝑝𝑒 = 𝐼𝑛𝑣𝑒𝑟𝑠𝑒 𝑜𝑓 𝑆𝑙𝑜𝑝𝑒 = 𝑃𝑟𝑖𝑐𝑒 𝐶𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 =
𝑟𝑢𝑛 𝑟𝑖𝑠𝑒 𝑃1−𝑃0

Quantity intercept is always negative. This is because no supplier is generally willing and able to provide
a good. There are exceptions however, for example if the government is providing subsidies to firms
producing a certain good. In this scenario, the quantity intercept may be positive. To solve for quantity
intercept, first substitute the price coefficient in the supply equation. Afterwards, select a point in the
supply curve, then substitute the price and quantity supplied of that point into the supply equation. After
which, you may already compute for the quantity intercept by means of algebra.

Price intercept of supply is the price at which producers are willing and able to provide a good. This can
be computed by substituting the quantity supplied by zero. Graphically, this is the point where the supply
curve begins.

Change in quantity intercept and price coefficient

In the event a change in determinants of supply, aside from price, occurs, this will indicate either an
increase or decrease in the supply in total. It reflects either a shift in the supply curve to the right or to the
left. Thus, in the supply equation, the net effect of the change is either added or subtracted to the
quantity intercept.

In the event a change in the price coefficient occurs, a change in the steepness of the curve will occur.
Subsequently, this will cause the supply curve to change from inelastic to elastic and vice versa or become
more elastic or more inelastic.

SOLVING FOR THE EQUILIBRIUM PRICE AND EQUILIBRIUM QUANTITY

To compute for the equilibrium price and quantity, first determine the demand and supply equation.
Afterwards, equate the two equations and manipulate to obtain the value of P. Equilibrium Price is
denoted as Pe.
To compute for the equilibrium quantity. Substitute the computed equilibrium price in either demand or
supply equation. For better results, substitute in both. At this point Qd must equal Qs.

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LESSON 9: Effect of Government Policies

E conomists have two roles. As scientists, they develop and test theories to explain the world around them.
As policy advisers, they use their theories to help change the world for the better. We have seen how
supply and demand determine the price of a good and the quantity of the good sold. We have also seen how
various events shift supply and demand and thereby change the equilibrium price and quantity. We should
analyze various types of government policy using only the tools of supply and demand. Policies often have
effects that their architects did not intend or anticipate.

PRICE CEILING

Not everyone may be happy with the outcome of this free-market process. Let’s say the consumers
complains that the ₱60.00 price is too high for everyone to ride a tricycle a day. Meanwhile, the National
Organization of Tricycle Drivers complains that the ₱60.00 price—the result of “cutthroat competition”—
is depressing the incomes of its members. Each of these groups lobbies the government to pass laws that
alter the market outcome by directly controlling prices.

Of course, because buyers of any good always want a lower price while sellers want a higher price, the
interests of the two groups conflict. If the consumers are successful in their lobbying, the government
imposes a legal maximum on the price at which tricycle services are sold. Because the price is not allowed
to rise above this level, the legislated maximum is called a price ceiling.

When the government, moved by the complaints of the consumers, imposes a price ceiling on the market
for ice cream, two outcomes are possible. In Figure 8-1, the government imposes a price ceiling of ₱90.00.
In this case, because the price that balances supply and demand (₱60.00) is below the ceiling, the price
ceiling is not binding. Market forces naturally move the economy to the equilibrium, and the price ceiling
has no effect. Figure 8-2 shows the other, more interesting, possibility. In this case, the government

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imposes a price ceiling of ₱40.00. Because the equilibrium price of ₱60.00 is above the price ceiling, the
ceiling is a binding constraint on the market.

120 120
100 100
80 80
60 Market Equilibrium 60 Market Equilibrium

40 40
20 20
0 0
20 40 60 80 100 20 40 60 80 100

Figure 8-1 Figure 8-2

The forces of supply and demand tend to move the price toward the equilibrium price, but when the
market price hits the ceiling, it can rise no further. Thus, the market price equals the price ceiling. At this
price, the quantity of tricycle rides demanded exceeds the quantity supplied. There is a shortage of ice
cream, so some people who want to ride tricycles at the going price are unable to.

PRICE FLOOR

By contrast, if the National Organization of Tricycle Drivers are successful, the government imposes a
legal minimum on the price. Because the price cannot fall below this level, the legislated minimum is
called a price floor. A price floor is the lowest legal price a commodity can be sold at. Price floors are used
by the government to prevent prices from being too low. The most common price floor is the minimum
wage--the minimum price that can be paid for labor.

To examine the effects of another kind of government price control, let’s return to the market for tricycle
rides. Imagine now that the government is persuaded by the pleas of the National Organization of
Tricycle Riders. In this case, the government might institute a price floor. Price floors, like price ceilings,
are an attempt by the government to maintain prices at other than equilibrium levels. Whereas a price
ceiling places a legal maximum on prices, a price floor places a legal minimum.

In Figure 8-3 the government imposes a price floor of ₱40.00. Because this is below the equilibrium price
of ₱60.00, the price floor has no effect. The market price adjusts to balance supply and demand. At the
equilibrium, quantity supplied, and quantity demanded are both equal. In Figure 8-4, the government
imposes a price floor of ₱80.00, which is above the equilibrium price of ₱60.00. Therefore, the market
price equals ₱80.00. Because 80 cones are supplied at this price and only 40 are demanded, there is a
surplus of 40 tricycle rides.

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120 120
100 100
80 80
60 Market Equilibrium 60 Market Equilibrium

40 40
20 20
0 0
20 40 60 80 100 20 40 60 80 100

Figure 8-3 Figure 8-4

TAXES

All governments—from the national government in Malacańang Palace, to the local governments in
small towns—use taxes to raise revenue for public projects, such as roads, schools, and national defense.

Taxes Levied on Buyers

We first consider a tax levied on buyers of a good. Suppose, for instance, that our local government
passes a law requiring consumers on tricycle rides to send ₱10.00 to the government for each tricycle ride
they avail. The initial impact of the tax is on the demand for tricycle rides. The supply curve is not affected
because, for any given price of a ride, sellers have the same incentive to provide tricycle services to the
market. By contrast, buyers now must pay a tax to the government (as well as the price to the sellers)
whenever they avail a tricycle ride. Thus, the tax shifts the demand curve for tricycle rides.

120

100

80

60 Old Market Equilibrium

New Market Equilibrium

40

20
=Tax Revenue

0 =Deadweight loss
20 40 60 80 100

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Taxes Levied on Suppliers

Suppose the local government passes a law requiring sellers/ operators of tricycles to send ₱10.00 to the
government for each time a consumer avails their service. In this case, the initial impact of the tax is on
the supply of tricycle rides. Because the tax is not levied on buyers, the quantity of tricycle rides
demanded at any given price is the same, so the demand curve does not change. By contrast, the tax on
sellers raises the cost of rendering tricycle services and leads sellers to supply a smaller quantity at every
price. The supply curve shifts to the left (or, equivalently, upward).

120

100

80

New Market Equilibrium

60
Old Market Equilibrium

40

20
=Tax Revenue

0 =Deadweight loss
20 40 60 80 100

Deadweight Loss

A tax reduces the quantity traded, thereby reducing some of the gains from trade. Consumer surplus falls
because the price to the buyer rises, and producer surplus (profit) falls because the price to the seller falls.
Some of those losses are captured in the form of the tax, but there is a loss captured by no party—the
value of the units that would have been exchanged were there no tax. The value of those units is given
by the demand, and the marginal cost of the units is given by the supply. The difference, shaded in black
in the figure, is the lost gains from trade of units that aren’t traded because of the tax. These lost gains
from trade are known as a deadweight loss. That is, the deadweight loss is the buyer’s values minus the
seller’s costs of units that are not economic to trade only because of a tax or other interference in the
market. The net lost gains from trade (measured in dollars) of these lost units are illustrated by the black
triangular region in the figure.

To compute the deadweight loss, simply compute for the area of the triangle (1/2 x base x height)

Elasticities and Tax Incidence

If the supply curve is elastic, and the demand curve is inelastic. In this case, the price received by sellers
falls only slightly, while the price paid by buyers rises substantially. Thus, buyers bear most of the burden
of the tax. However, if the supply curve is inelastic, and the demand curve is elastic. In this case, the price
received by sellers falls substantially, while the price paid by buyers rises only slightly. Thus, sellers bear
most of the burden of the tax.

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CASE STUDY: TAAL VOLCANO ERUPTION AND N95 MASKS

On January 14, 2020, President Rodrigo Duterte sad that he would talk to Health officials about setting a
price cap for face masks, amid reports of overpricing. Speaking to media in Taguig, Duterte said he would
not be surprised if prices of face masks go up after the eruption of Taal Volcano, but sellers should not
take advantage of the situation.

I am not surprised because, with sellers, if the demand is high and if stocks are low, then prices go up. Or
worst thing they can do, if they have enough supplies and yet they’re selling it at prohibitive prices. So,
I’m setting the limit,” he said.

Duterte said he would take up the matter with Health Secretary Francisco Duque III.

“It’s so cheap… do not hoard it. If you kept them, then I will be forced to raid your store,’ he said.

The President also said the government would distribute face mask to those who cannot afford it.

With ash reaching nearby areas, health officials have advised using an N95 respirator mask, which
protects against 95% of airborne particles – such as those spewed by the Taal Volcano in Batangas. But
there are several reports that businesses are hiking prices. Manila City Vice-Mayor Honey Lacuna-Pangan
said her office has received complaints that N95 masks were being sold for ₱200.00, from the previous
₱30.00.

“Those found to have unreasonably increased their prices for gas masks, face masks and other similar
items, which act is tantamount to profiteering, shall be dealt with the fullest extent of the law,” the
Department of Trade and Industry said.

Taken from cnnphilippines.com/news/2020/1/14/duterte-price-cap-face-mask.html

The Department of Health (DOH) has ordered a temporary stop in the increase in prices of medicines and
medical supplies in areas affected by the Taal Volcano Eruption.

Health Secretary Francisco Duque III signed the department memorandum following confirmed reports
of profiteering and hoarding.

DOH set the lowest and maximum ceiling prices for emergency medicines, such as analgesics,
antibacterial medicines, respiratory tract medicines, and anti-asthma medicines.

Price freeze was also set for medical supplies, such as the highly in demand N95 masks. DOH said the
N95 mask should cost between ₱45- ₱150, while disposable masks should cost a maximum of ₱8.00 per
piece.

Taken from cnnphilippines.com/news/2020/1/15/Taal-Volcano-eruption-N95-mask-price.html

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LESSON 10: Market Structures

E conomists have two roles. As scientists, they develop and test theories to explain the world around them.
As policy advisers, they use their theories to help change the world for the better. We have seen how
supply and demand determine the price of a good and the quantity of the good sold. We have also seen how
various events shift supply and demand and thereby change the equilibrium price and quantity. We should
analyze various types of government policy using only the tools of supply and demand. Policies often have
effects that their architects did not intend or anticipate.

MARKET STRUCTURE

Market structure is best defined as the organizational and other characteristics of a market. We focus on
those characteristics which affect the nature of competition and pricing – but it is important not to place
too much emphasis simply on the market share of the existing firms in an industry. The elements of
market structure include the number and size distribution of firms, entry conditions, and the extent of
differentiation.

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There are four basic types of market structures by traditional economic analysis:

1. Monopoly 3. Perfect Competition

2. Oligopoly 4. Monopolistic Competition

MONOPOLY

A monopoly is market structure in which there is only one producer/ seller for a product. In other words,
the single business is the industry. Entry into such a market is restricted due to high costs or other
impediments, which may be economic, social, or political. For instance, the government can create a
monopoly over an industry that it wants to control, such as electricity. Another reason for the barriers
against entry into a monopolistic industry is that oftentimes, one entity has exclusive rights to a natural
resource. A monopoly may also form when a company has a copy right or patent that prevents others
from entering the market. Pfizer for instance, had a patent on Viagra.

There is a tendency for monopolist to maximize profits and being the only one in the market, will not
think too much for consumers’ welfare. If monopolies will not be regulated, the cost of products would
be costing much more now.

Public welfare dictates that the government should take a more active role in the regulation of
monopolies. Monopolies could not just be left alone by the government in the same way as other
industries in the more competitive models are left alone.

Characteristics of Monopoly

1. Maximizes profit;
2. Decides the price of the good or product to be sold, but does so by determining the quantity in
order to demand the price desired by the firm;
3. Other sellers are unable to enter the market of the monopoly;
4. In a monopoly, there is one seller of the good that produces all the output. The whole market is
being served by a single company, and for practical purposes, the company is the same as the
industry;
5. A monopolist can change the price and quantity of the product. He or she sells higher quantities,
charging a lower price for the product, in a very elastic market and sells lower quantities, charging
a higher price in a less elastic market.

OLIGOPOLY

In an oligopoly, there are only a few firms that make up an industry. This select group of firms has control
over the price and, like a monopoly, an oligopoly has high barriers to entry. The products that the
oligopolistic firms produce are often nearly identical and, therefore, the companies, which are competing
for market share, are interdependent as a result of market forces. One example is the market for tennis
balls. Another is the world market for crude oil: A few countries in the Middle East control much of the
world’s oil reserves.

Oligopoly situations usually invite collusion or a secret agreement between two or more persons or
institutions to achieve certain objectives among industry ‘s firms. Mutual interdependence among firms
could also manifest itself into spontaneous coordination of the policies of the firms.

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Most jurisdictions have laws against fixing and collusion. An oligopoly in which participants explicitly
engage in price fixing is a cartel: OPEC (Organization of Petroleum Exporting Countries) is an example.
Tacit collusion, on the other hand, is perhaps more common though more difficult to detect. A stable
oligopoly will often have a price leader; when the leader raises the price, the others will follow.

Characteristics of Oligopoly

1. Maximizes profit;
2. Oligopolies are price setters rather than price takers;
3. Barriers to entry are high. The most important barriers are government licenses, economies of
scale, patents, access to expensive and complex technology, and strategic actions by incumbent
firms designed to discourage or destroy promising firms;
4. There are so few firms that the actions of one firm can influence the action of the other firms;
5. Products may be homogenous or differentiated;
6. Oligopolies have perfect knowledge of their own cost and demand functions bit their inter-firm
information may be incomplete. Buyers have only imperfect knowledge as to price, cost, and
product quality

MONOPOLISTIC COMPETITION

Monopolistic competition is a type of imperfect competition such as one or more producers sell products
that are differentiated from one another as goods but not perfect substitutes. In monopolistic
competition, a firm takes the prices charged by its rivals as given and ignores the impact of its own prices
on the prices of other firms

Monopolistic competition describes a market structure in which there are many firms selling products
that are similar but not identical. Examples include the markets for novels, movies, CDs, and computer
games. In a monopolistically competitive market, each firm has a monopoly over the product it makes,
but many other firms make similar products that compete for the same customers.

Characteristics of Monopolistic Competition

1. There are many producers and many consumers in the market, and no business has total control
over the market price.
2. Consumers perceive that there are non-price differences among the competitors’ products.
3. There are few barriers to entry and exit.
4. Producers have a degree of control over price.

PERFECT COMPETITION

Perfect competition is characterized by many buyers and sellers, many products that are similar in nature
and, as a result, many substitutes. Perfect competition means there are few barriers to entry for new
firms and prices are determined by demand and supply. Thus, producers in a perfectly competitive
market are subject to the prices determined by the market and do not have any leverage. One example
is in a wet market, where sellers of agricultural produce tend to keep the prices of the goods the same.

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Characteristics of Perfect Competition

1. There is perfect knowledge, with no information failure or time lags in the flow of information.
Knowledge is freely available to all participants, which means risk-taking is minimal and the role
of entrepreneur is limited.
2. Given that producers and consumers have perfect knowledge, it is assumed that they make
rational decisions to maximize their self-interest – consumers look to maximize their utility, and
producers look into maximizing profits.
3. There are no barriers to entry or exit out of the market.
4. Firms produce homogenous, identical units of output that are not branded.
5. Each unit of input, such as units of labor, are also homogenous.
6. No single firm can influence the market price or market conditions. The single firm is said to be a
price taker, taking its price from the whole industry.
7. There are very many firms in the market – too many to measure. This is a result of having no
barriers to entry.
8. There is no need for government regulation, except to make markets more competitive.
9. There are assumed to be no externalities, that is no external costs or benefits to third parties not
involved in the transaction.

Below is a summary of the four types of market structure. The first question to ask about any market is
how many firms there are. If there is only one firm, the market is a monopoly. If there are only a few firms,
the market is an oligopoly. If there are many firms, we need to ask another question: Do the firms sell
identical or differentiated products? If the many firms sell differentiated products, the market is
monopolistically competitive. If the many firms sell identical products, the market is perfectly
competitive.

One firm Monopoly

Perfect
Few firms Oligopoly competition
Number of
firms?

Type of Monopolistic
Many firms
product? Differnatiated Competition
products

REFERENCES

Leańo, R (2016). Applied Economics for Senior High School. Intramuros, Manila: Mindshapers Co., Inc.

Mankiw, G (2002). Principles of Economics. USA: Harcourt, Inc.

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QUIZZER

Multiple Choice: Choose the letter of the correct answer and write it down on the space provided for in
each item.

1. The ideal market structure:

A. monopoly
B. monopolistic competition
C. Perfect competition
D. Oligopoly

2. There are no barriers of entry in this market

A. monopoly
B. monopolistic competition
C. Perfect competition
D. Oligopoly

3. The equilibrium price in this market is equal to:

A. 6 per unit
B. 5 per unit.
C. 4 per unit.
D. 3 per unit.

4. At a price of 8, there is:

A. Excess demand (a shortage) of 25 units.
B. Excess demand (a shortage) of 15 units.
C. Excess supply (a surplus) of 15 units.
D. Excess supply (a surplus) of 25 units.

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PROBLEM SOLVING

1. Suppose that we have the following data

Year Price of iron ore per ton Demand Supply
A ₱20,000 70,000 tons 80,000 tons
B ₱50,000 50,000 tons 60,000 tons
C ₱80,000 30,000 tons 40,000 tons

A. Construct a demand equation

B. Construct a supply equation
C. Compute for the equilibrium price and equilibrium quantity
D. Assume that the government imposed a price ceiling of ₱45,000, ceteris paribus, what is the new
equilibrium price and equilibrium quantity?
E. Assume that the government is now taxing the buyers of iron ore, this caused the equilibrium
quantity for iron ore to lower by 10,000 tons. Is the deadweight loss caused by the tax imposition
causing the economy to be inefficient?

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