University of Engineering and

Technology Lahore

Chemical Engineering Economics

Che-309
Instructor: Aamir Abbas

Introduction to economics: Demand, supply and

governmental policies
 Learning Objectives
 To get the idea about price elasticity of
demand.
To study the supply, demand, and their
relation with government policies
 To define price ceiling and price floor.
 To learn about taxes.


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 Price elasticity of demand
 It is a measure of how much the quantity
demanded of a good responds to a change in
the price of that good, computed as the
percentage change in quantity demanded
divided by the percentage change in price.

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 Elastic and inelastic demand
 Demand for a good is said to be elastic if the
quantity demanded responds substantially to
changes in the price.

Demand is said to be inelastic if the quantity

demanded responds only slightly to changes in
the price.

 Necessities tend to have inelastic demands,

whereas luxuries have elastic demands.

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Price elasticity of demand

5
 Price elasticity of demand

Demand is elastic when the elasticity is greater than 1, so that quantity moves
proportionately more than the price.
6
 Price elasticity of demand

Demand is inelastic when the elasticity is less than 1, so that quantity moves
proportionately less than the price.
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 Price elasticity of demand

Demand is perfectly inelastic, and the demand curve is vertical

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 Supply, Demand, and Government
Policies
 In a free, unregulated market system, market
forces establish equilibrium prices and
exchange quantities (As discussed in last
lectures).
 One of the things government can do is to set
price controls when the market price is seen
as unfair to either buyers or sellers.

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 Price Ceilings & Price Floors
 Price Ceiling
A legally established maximum price at which a
good can be sold. (Rent Controls)

 Price Floor
A legally established minimum price at which a
good can be sold. (Price Supports for Agriculture)

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 Price Ceilings
Two outcomes are possible when the
government imposes a price ceiling:
 The price ceiling is not binding if set above
the equilibrium price.

The price ceiling is binding if set below the

equilibrium price, leading to a shortage.

Binding means that there is an economic

impact.

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 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

A Price Ceiling That Is Not Binding...

Price of
Ice-Cream
Cone
Supply

$4 Price
ceiling

Equilibrium
price

Demand

0 100 Quantity of
Equilibrium Ice-Cream
quantity Cones 12
 Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.

A Price Ceiling That Is Binding...

Price of
Ice-Cream
Cone
Supply

Equilibrium
price

$3

2 Price
ceiling
Shortage
Demand

0 75 125 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones 13
 Case study for gasoline
• In 1973 OPEC raised the price of crude.
• The higher oil prices reduced the supply of
gasoline.
• Before increase in price by OPEC, price of
gasoline was below price ceiling so no effect.
• With increase in price of crude situation
changed, reduced the supply of gasoline due
increase in cost of crude.
• Result shortage.

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 The Price Ceiling on Gasoline Is Not Binding...
Price of
Gasoline

1. Initially, Supply
the
price ceiling
is not
binding... $4 Price
ceiling

P1

Demand

0 Quantity of
Q1 Gasoline
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 The Price Ceiling on Gasoline Is Binding...
Price of S2 2. …but
Gasoline when supply
falls...
S1
P2
Price
ceiling

P1 3. …the price
ceiling becomes
4. …resulting binding...
in a shortage.

Demand

0 Quantity of
Q1 Gasoline
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 Effects of Price Ceilings
A binding price ceiling creates,

 Shortages because QD > QS.

 Example: Gasoline shortage of the 1970s

 nonprice rationing
 Examples: Long lines, Discrimination by sellers

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 What are some potential impacts of
taxes?
 Taxes are used to raise money for the
government.
 Taxes discourage market activity.
 When a good is taxed, the quantity sold is
smaller.
 Buyers and sellers share the tax burden.
 But finally who bears the burden-tax
incidence.

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 Copyright © 2001 by Harcourt, Inc. All rights reserved

Impact of a 50¢ Tax on Sellers...

Price of
Ice-Cream
Cone A tax on sellers
Price S2 shifts the
buyers Equilibrium
supply curve
pay with tax
upward by the
$3.30 S1 amount of the
Price 3.00 Tax ($0.50)
tax ($0.50).
without 2.80
tax Equilibrium without tax

Price
sellers
receive

Demand, D1

0 90 100 Quantity of 19
Ice-Cream Cones
 Copyright © 2001 by Harcourt, Inc. All rights reserved

Impact of a 50¢ Tax Levied on Buyers...

Price of
Ice-Cream
Cone Supply, S1
Price
buyers
pay $3.30 Equilibrium without tax
Price 3.00 Tax ($0.50)
without 2.80
tax

Price
Equilibrium
sellers with tax
receive
D1
D2

0 90 100 Quantity of 20
Ice-Cream Cones
 The Incidence of Tax
 In what proportions is the burden of the tax
divided?
 How do the effects of taxes on sellers compare
to those levied on buyers?

The answers to these questions depend on the elasticity of demand

and the elasticity of supply.

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“In this world nothing is certain but death and taxes.”
. . . Benjamin Franklin
100

Today, taxes
80

account for up
60

to a third of
40

the average
American’s
20

income.
0

1789 Today
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 Summary
 Price elasticity of demand.
 Price floor and ceiling.
 Bonding and non-binding effect.
 Taxes

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