Session 5

Elasticity & DD-SS Applications

(Government interventions in the market)

Prof Subramania Raju Rajasulochana

Associate Professor
SBM, NMIMS Mumbai
Review
• Point versus Arc Elasticity
• Range of Price Elasticity of Demand (5 kinds)
• Elasticity- Linear versus Non linear
• Factors affecting demand elasticity
• Short Run vs. Long Run Price Elasticity
Demand Elasticity & Revenue
 Mid-point
Price
Demand Price TR MR AR ∆price avgprice ∆quantity avgquantity Elasticity
1 100
2 90
3 80
4 70
5 60
6 50
7 40
8 30
9 20
10 10
 Mid-point
Price
Demand Price TR MR AR ∆price avgprice ∆quantity avgquantity Elasticity
1 100 100
2 90 180 80 90 -10 95 1 1.5 -6.33
3 80 240 60 80 -10 85 1 2.5 -3.40
4 70 280 40 70 -10 75 1 3.5 -2.14
5 60 300 20 60 -10 65 1 4.5 -1.44
6 50 300 0 50 -10 55 1 5.5 -1.00
7 40 280 -20 40 -10 45 1 6.5 -0.69
8 30 240 -40 30 -10 35 1 7.5 -0.47
9 20 180 -60 20 -10 25 1 8.5 -0.29
10 10 100 -80 10 -10 15 1 9.5 -0.16
Observations

• TR increases initially, reaches maximum and eventually starts falling.

• TR is maximum when MR =0.
• AR = price
• MR is falling faster than AR.
• AR is always positive, but MR becomes negative(as TR falls).
• TR is maximum when price elasticity is -1.
Graphically, the relation between Price Elasticity and Marginal Revenue
Q#15
Q#22
Government interventions in the market
• refers to when a government declaring as a rule maker or market regulator
must intervene deeply in transaction disputes between market players,
mobilizing public or private resources to resolve the transaction disputes in
the process of market governance.
• Governments intervene in markets to try and overcome market failure. The
government may also seek to improve the distribution of resources
(greater equality).
• Forms of government intervention in markets
Price ceiling : Minimum support prices/wages & Maximum prices/Rent
control
 Taxes
 Nudges/Behavioural unit
Price Controls/ceiling

EFFECTS OF PRICE
CONTROLS
Without price controls, the market clears
at the equilibrium price and quantity P0
and Q0.
If price is regulated to be no higher than
Pmax, the quantity supplied falls to Q1,
the quantity demanded increases to Q2,
and a shortage develops.
Floor prices (Minimum Support Prices for Farmers)

A minimum price will lead to a surplus (Q3 – Q1). Therefore

the government will need to buy the surplus and store it.
Problems of minimum prices
1.It could be costly for the government to buy the surplus
2.A minimum price guarantee acts as an incentive for farmers
to try and increase supply. As an unintended consequence,
the minimum price encourages more supply than expected
and the cost for the government rises.
3.To ensure minimum prices, the government may have to
put tariffs on cheap imports – which damages the welfare of
farmers in other countries.
SEA demands government intervention as mustard prices drop below MSP
Expressing concern over rape-mustard seed rates falling below the minimum support
price (MSP), edible oil industry body SEA on Tuesday demanded the government
commence procurement and restrict imports.
Solvent Extractors Association of India (SEA), in a representation to both food and
commerce secretaries, said mustard seed prices in the wholesale market yards have
crashed below the MSP of Rs 5,450 per quintal and the arrivals are increasing on a daily
basis.
"Further drop in prices cannot be ruled out," SEA Executive Director B V Mehta said.
He also noted that unbridled imports of refined palm oil have led to the collapse in
domestic edible oil prices which is impacting the marketing of mustard seed at peak
harvest time and causing distress to farmers.
"We feel heavy imports of refined palmolein are neither helping our mustard farmer nor the
Indian refining industry," he said.

To arrest further fall in prices, SEA has suggested the government restrict the import of
Illustrate the conditions in the refined palm oil by putting the commodity under the restricted category or by raising the
domestic edible oil market with a import duty differential between crude palm oil (CPO) and Palmolein to a minimum of 20
per cent.
suitable diagram.
Besides, the government through agencies like Nafed can begin the procurement of
mustard at MSP, it added.

According to the official data, rapeseed-mustard has been sown in a higher area at 98.02
lakh hectares in the current 2022-23 crop year (July-June).
Tax
Tax

• Tax is a method to discourage

consumption of certain goods. For
example, taxes on demerit goods –
goods with negative externalities.
• Taxes both discourage
consumption and raise revenue for
the government.
• In the diagram, the tax moves
output to Q2 and price to P2.
Numerical illustration…
• Initial Qd= 35-5P and Qs =-5+ 5P.
• Find equilibrium price and quantity.
• P=4 and Q= 15
• Now suppose the government imposes an excise tax of $1 per unit,
which it will collect from the sellers. What will be the market-clearing
price and quantity after the imposition of the new excise tax?
• Will it be $1 more than before, $5 or less?
• Qs = -5 + 5(P-T)= -5 +5P-5= -10+ 5P.
• New Equilibrium: 35-5P=-10+5P; 45=10P  P=4.5 and Q=12.5
Incidence of a Tax Depends on Elasticity of Supply and Demand

• The sharing of the tax

burden depends on
relative Ed and Es .
• The more elastic the Ed,
the lesser burden on
consumers.
• Percentage of tax borne by
consumers = Es/(Es-Ed)

(a) If demand is very inelastic relative (b) If demand is very elastic relative to
to supply, the burden of the tax falls supply, it falls mostly on sellers.
mostly on buyers.