Government and

Market
Prepared by:
Md Nasir bin Daud, Prof Dr
 Comparison of Markets
Market Perfect Monopoly Monopolistic Oligopoly
characteristics competition
Buyers and Both in large One seller and Both in large Sellers small and
sellers numbers many buyers numbers buyers large
numbers
Product Homogenous and No close Differentiated Homogeneous
characteristic perfectly substitutes through design, for different
substitutable branding and products that are
packaging close substitutes
Freedom of Freedom to enter Barriers to new Freedom to enter Barriers to new
exit and entry or leave firms’ entry or leave firms’ entry

Shape of Horizontal Slanting, less Slanting, more Slanting

DD/AC curve (perfectly elastic) elastic elastic

Monopolistic No Yes Yes, but lesser Yes

control than monopoly
 Comparison of Markets
Market Perfect Monopoly Monopolistic Oligopoly
characteristics competition
Price control Price-taker; no Price-taker; Some control on Some control on
control on price dictates the price the price the price
Allocative Yes; produce at P No; produce at P No; produce at P No; produce at P
efficiency = MC > MC > MC > MC

Non-price Does not get Seldom involved Involved in non- Involved in non-
competition involved price competition price competition

Profit in the Normal profit Supernormal Normal profit Supernormal or

long-run profit normal profit

Productive Yes; production is No; production is No; production is No; production is

efficiency at optimum lower than lower than lower than
optimum optimum optimum
 Controls on Prices
• Enacted when policy makers believe that the market
price of a good or service is unfair to buyers or sellers.
• Done by imposing a price ceiling or a price floor.
• Imposing a price ceiling introduces a binding
constraint, or a non-binding one, depending on what
price is fixed.
• When government introduces a binding price ceiling on
a competitive market, a shortage of the goods arises,
and sellers must ration them among potential buyers.
 Controls on House Rents: An example
• In some cities, authorities places a ceiling on rents (below the
market level) in order to make housing more affordable to the poor.
The ceiling price creates a shortage.
• In the short run, the shortage is small since supply and demand are
both relatively inelastic.
• But in the long run, the shortage is larger when the supply falls
substantially and demand rises substantially too, as market has time
to react to the new price.
• The resultant shortage leads to various means to ration housing,
some of which may not be desirable nor economic.
• Authorities may introduce extra regulations, which could be difficult
and expensive to implement.
 Effects of Floor Prices
• A price floor places a legal minimum on prices.
• When the floor price becomes a binding
constraint, it causes a surplus – some of the
quantities are not able to be sold
• Mechanisms for selling the stock will be
resorted to, not all of which are desirable.
 The Minimum Wage: An example
• When the minimum wage is above the
equilibrium, the quantity of labour supplied
exceeds that demanded, resulting in
unemployment.
• Thus, the minimum wage raises the income of
those in job, but lowers the income of those out
of job.
• The effect may not be felt by the skilled and
experienced workers whose wage is higher than
the minimum wage anyway.
 Taxes
• Taxes are needed to raise revenues for public
projects.
• When a tax is introduced on goods, who actually
bears the burden of the tax?
• If buyer and seller share the burden, what
determines how the burden is divided?
• Can government simply legislate the division? Or
is the division determined by more fundamental
market forces?
 How Taxes on Sellers Affect Market
Outcomes
• Sellers will get the immediate impact of the tax.
• The demand curve does not change. But the supply curve does,
shifting to the left. The shift is by the exact amount of the tax.
• The equilibrium price of the good rises and the equilibrium quantity
falls. Because buyers buy less and sellers sell less in the new
equilibrium, the tax reduces the goods market.
• In fact, buyers and sellers share the burden. The tax makes buyers
worse off by having to pay higher prices, and makes sellers worse
off by having some amount skimmed off the original price.
• Thus, taxes discourage market activity by lowering the qunatity of
goods sold. Buyers and sellers share the burden, with buyers paying
more and sellers receiving less.
 How Taxes on Buyers Affect Market
Outcomes
• The immediate impact is on the demand for the goods.
• The supply curve does not change. But the demand curve does,
shifting to the left. The shift is by the exact amount of the tax.
• The equilibrium price of the good falls and the equilibrium quantity
falls. Because buyers buy less and sellers sell less in the new
equilibrium, the tax reduces the goods market.
• In fact, buyers and sellers share the burden. The tax makes sellers
worse off by getting a lower price for the goods, and makes buyers
worse off by paying a higher total price than the original price.
• Thus, taxes discourage market activity by lowering the quantity of
goods sold. Buyers and sellers share the burden, with buyers paying
more and sellers receiving less.
 Elasticity and Tax Incidence
• How exactly is the tax burden divided?
• A tax burden falls more heavily on the side of the market
that is less elastic.
• In conclusion, the economy is governed by the laws of
supply and laws of demand. Price controls and taxes are
common in various economies. When analysing
government policies, supply and demand are the first
and most useful tools of analysis.