CHAPTER1: What economics is all about
CHAPTER 2: Important concepts, issues and relationships
CHAPTER 3: Demand, supply and prices
CHAPTER 4: Demand and supply in action
ECO 151
MICROECONOMICS
NOTES
Sesethu Mdanyana
DEFINITIONS
Microeconomics- is the social science that studies the implications of incentives and decisions,
specifically how those affect the utilization and distribution of resources on an individual level.
Macroeconomic- is a branch of economics that studies the behaviour of an overall economy,
which encompasses markets, businesses, consumers and governments.
Explicit monetary costs- are normal business costs that appear in a company’s general ledger
and directly affect its profitability.
Implicit costs- is an opportunity cost that arises when a company uses internal resources
without any explicit compensation.
Intermediate goods- are goods that are purchased to be used as inputs in producing other
goods.
Economic goods- is a good that is produced at a cost from scarce resources.
Homogeneous goods- are goods that are all exactly alike, such as, oil, fruits and vegetables.
heterogeneous good- are different goods, are available in different varieties, qualities or
brands, such as, bread or clothes.
The production possibilities curve- indicates the combinations of any two goods or services
that are attainable when the community’s resources are fully and efficiently employed.
System- is a network of parts, which interlock to form an overall pattern.
Economic system- is a pattern of organisation that is aimed at solving the three economic
questions.
Final goods- goods used by individuals, households and firms. E.g. bread, brick.
Intermediate goods- goods used as inputs in producing other goods. E.g. flour, cement.
Private goods – goods that others are excluded from using for free. E.g. airplane rides, cell
phone and food.
Public goods- goods used by community, they are provided by the government. E.g.
streetlights, roads, bridges, national defence.
Market- is any contact or communication between potential buyers and potential sellers of a
good or a service.
Property rights- refers to the right to possess, use or dispose of tangible assets and intangible
assets (e.g. patent).
Coordinating mechanism- is a mean of providing and transmitting information so as to
coordinate the economic activities of the great number of participants in an economy.
Capitalist market- refers to an economic system where most means of production are privately
owned, and production and income distribution are largely guided by the operation of
markets.
Mixed capitalist economy- refers to an economy where not all the productive assets are in the
hands of private people, but that some are government owned.
Centrally planned socialism- is an economic system characterised by public ownership of
factors of production.
Mixed command economy- is a planned economy that also makes use of markets and private
initiative.
Communism- is a political system rather than an economic system. Is a system of social
organisation in which all property is owned by the community and each person contributes
and receive according to their ability and needs.
Privatisation- refers to when government-owned business, operation or property become
owned by a private entity.
Nationalisation- is the process of transforming privately-owned assets into public assets by
bringing them under the public ownership of a national government or state.
Aggregate consumption expenditure- refers to the total spending of all households on
consumer goods and services.
Monetary flow- is the flow of income and spending.
Demand- refers to the quantities of a good or service that the potential buyers are willing and
able to buy.
Complements- refers to goods that are used jointly.
Substitute goods- refers to goods which can be used instead of the good in question.
Demand schedule- is a table that lists the quantities demanded at different prices when all
other influences on planned purchases are held constant.
Demand curve- is a simple and useful way of indicating the relationship between then quantity
demanded and the price of a good or service, on the assumption that all other determinations
are constant.
Normal good- is a good that experiences an increase in demand due to an increase in
consumer’s income. E.g. food, clothing, household appliances.
Inferior good- is a product whose demand decreases when people’s income rises. E.g. cheap
cars, inexpensive food, public transit options, low-end clothing.
Equilibrium- is a state of rest in which opposing forces are balanced and in which there is no
tendency for things to change (as long as the underlying forces remain the same).
Consumer surplus- is the difference between what consumers pay and the value they receive
which is indicated by their willingness to pay.
Producer surplus- is the difference between what producers are willing to produce at and the
price that they receive.
Maximum price- is a cap or limit on the price that a good or service can reach.
Minimum price- is lowest price that can legally be set for a good or service.
Deadweight loss- refers to the loss of economic efficiency that occurs when the equilibrium
outcome is not achievable due to market inefficiency.
Subsidies- are direct or indirect payments from the government to individuals or firms, to help
reduce the cost of production and increase consumption of certain products.
NOTES
CHAPTER 1: WHAT ECONOMICS IS ALL ABOUT
Economics is a social science that studies how individuals, governments, firms and nations
make necessary(necessitate) choices on allocating scarce resources to satisfy their unlimited
wants.
Microeconomics and macroeconomics
Microeconomics focus on individual parts of the economy, while macroeconomics focus on
the economy as a whole.
Distinction between microeconomics and macroeconomics
Microeconomics, we study
Macroeconomics, we study
The price of a single product
The consumer price index
Changes in the price of a product
Inflation
The production of a product
The total output of all goods and services in
the economy
The decisions of an individual consumer
The combined outcome of the decisions of
all consumers in the country
The decisions of an individual firm or The combined decisions of all firms in SA
business
The demand for a product
The demand for all goods and services in the
economy
An individual’s decision whether or not to The total supply of labour in the economy
work
A firm’s decision whether or not to expand Changes in the total supply of goods and
its production of a product, e.g. motorcars
services in the economy
A firm’s decision to export its product
The total exports of goods and services to
other countries
A firm’s decision to import a product from The total imports of goods and services from
abroad
other countries
Scarcity, choice and opportunity cost
Needs are necessities, wants are human desire and demands are wants backed by purchasing
power (wants one wants when they have the necessary means to purchase them).
Resources are the means with which goods and services can be produced (also known as
factors of production).
All individuals and societies have to make choices because of unlimited wants and limited
means. When firms use resources to produce a certain good, they won’t be able to produce
other goods due to scarce resource. There are always costs involved in any use of scarce
resources. Scarcity affects everyone even the rich and government are also subjected to it.
Opportunity cost represents the potential benefits that a business, an investor, or an
individual consumer misses out on when choosing one alternative over another. Every time a
choice is made, opportunity costs are incurred.
Scarce resources: the factors of production
Factors of production are scarce resources that are used to produce goods and services.

Natural resources

Labour

Capital

Entrepreneurship

Technology
Primary factors of production: natural resources and labour
Secondary factors of production: capital and entrepreneurship
Human resources: labour and entrepreneurship
Non-human resources: natural resources and capital
Illustrating scarcity, choice and opportunity cost: the production possibilities curve
Possibility
Fish (baskets per day)
Potatoes (kg per day)
A
0
100
B
1
95
C
2
85
D
3
70
E
4
40
F
5
O
The production possibilities curve shows the maximum possible levels of output in an
economy with limited resources and fixed production techniques.
The various points on the curve show the combinations of fish and potatoes that can be
produced daily with the available resources.
The production possibilities curve is a very useful way of illustrating scarcity, choice and
opportunity cost.

Scarcity is illustrated by the fact that all points to the right of the curve (such as G) are
unattainable.

Choice is illustrated by the need to choose among the available combinations (such as
A, B, C, D, E, F) along the curve.

Opportunity cost is illustrated by what we refer to as the negative slope of the curve,
meaning more of one good can be obtained only by sacrificing the other good.
Description
Illustrated by
Attainable combinations
All points on or inside the PPC
Unattainable combinations
All points beyond the PPC
Efficient combinations
All points on the PPC
Inefficient combinations
All points inside the PPC
Increase in potential output
Outward shift of the PPC
CHAPTER 2: IMPORTANT CONCEPTS, ISSUES AND RELATIONSHIPS
Different economic systems
Three economic questions:

What goods and services will be produced and in what quantities? This part consists
of output questions.

How will each of the goods and services be produced? How many scarce resources will
be used in the production of each good? This deals with input questions.

For whom will the various goods and services be produced? Who will receive the goods
and services? These are distribution questions.
What gets produces?
Goods (tangible objects like food, clothes, cars) and services (intangible things like medical
services, financial services, travel services).
Types of goods

Consumer goods- goods used or consumed by individuals/households (durable goods,
semi-durable goods and non-durable goods).

Capital goods- goods used in production of other goods (sewing machine).
Characteristics of goods

Final goods

Intermediate goods

Private goods

Public goods
How will these goods and services be produced?
Using a combination of factors of production, namely:

Natural resources

Labour (deals with quality and quantity of the work)

Capital

Entrepreneurship

Technology
For whom will these goods and services be produced?

Goods and services are produced to satisfy human wants.

The consumption of these goods depends on the income.

These goods and services are produced for people who have the necessary means to
purchase them.
Basic mechanisms that are used to solve these questions.
The traditional system

Is a system that produce same goods and distribute them in the same way by each
successive generation (no innovation).

Each participant’s tasks and methods of production are prescribed by custom.

Provides clear and easy answers to the three central questions, however, it takes time
to adapt to changing conditions and resists innovation.
The command system

The participants are instructed what to produce and how to produce it by a central
authority.

This system is called centrally planned system, because the economy is governed and
coordinated by central authority.

Every decision regarding a task at hand have to be taken by the planners.
The market system

Free and spontaneous movement of market price, determined by the operation of the
supply and demand.
For a market to exist, the following conditions have to be met:

There must be a potential buyer and seller of the good and service.

The seller must have something to sell.

The buyer must have the means with which to purchase it.

Market price must be determined.
The mixed economy

Is a mixture of traditional behaviour, central control and market determination.

Private property, private initiative, self-interest (consumer satisfaction) and the market
mechanism all play an important role.
Production, income and spending
Production aims to use or consume the products to satisfy human wants.
Production creates income (earned in the production process by the various factors of
production), and this income is then spent to purchase the products.
In reality major elements happen simultaneously: production occur, income is earned, and
part or all the income is spent on buying goods and services. This flow is continuous.
Production, income and spending are all flow variables (measured over a period of time); this
is different from stock variables (measured at a particular point in time).
Production
Income
Factors of production
Rewards/earnings
Spending
of
the Expenditure by all sectors of
factors of production
the economy
Natural resource
Rent
Consumption expenditure (C
Labour
Wages and salaries
Investment expenditure (I)
Capital
Interest
Government spending (G)
Entrepreneur
Profit
Foreign sector (X-Z)
Apart from the three major flows, an important economic activity that links the various sectors
in an economy is exchange (exchange of goods, services and factors of production in markets).
Interdependence between households and firms
Households

Can be defined as all the people who live together and make joint economic decisions
or who are subjected to others who make such decisions for them.

Is the basic decision-making unit in the economy.

Members of households consume goods and services to satisfy their wants, therefore
they are called consumers- the act of using or consuming goods and services is called
consumption.

Symbol C indicates total consumption in the economy.

In a mixed economy, households own most of the factors of production, e.g. their own
labour, own capital goods used for production, even largely companies are owned by
shareholders.

Households sell their factors of production to firms that combine these factors and
convert them into goods and services.

We assume in economics, that consumers are rational, meaning that households
always seek to maximise the satisfaction they get from the goods and services they
buy.

E.g. if you get greater satisfaction from drinking coffee than tea, then it would be a
rational decision to buy coffee instead of tea so that you maximise your own
satisfaction.
Firms

Can be defines as the unit that employs factors of production to produce goods and
services that are sold in the goods market.

Firms are the basic productive units in the economy- they are engaged primarily in
production.

Firms are the units that convert factors of production into goods and services that
households desire.

In a market economy, it is firms that largely decide how goods and services will be
produced.

We assume that firms are also rational, they always aim to achieve maximum profit.

Firms purchase capital goods such as machinery and equipment, to produce other
goods with.

This purchase of capital goods is called investment or capital formation which is
denoted by the symbol I.
The circular flows
Goods market is a market where there is any contact or communication between potential
buyers and potential sellers of a good and service. In macroeconomics, we aggregate all goods
and services to form just one market, which is the goods market. In microeconomics, we
consider the markets for the individual goods and services.
Factor market is a market where factors of production are purchased and sold. This market
include the labour market and the markets for capital goods. In macroeconomics, we tend to
aggregate all the factor markets as if there were only one factor of production. In
microeconomics, we look at the individual factor markets.
The circular flow of goods and services
This flow illustrate the interaction between households and firms. Circular flow of goods and
services is the most basic description of the production process in the economy.
The households offer their factors of production for sale on the factor market, where these
factors are purchased by the firms. The firms combine them and produce consumer goods
and services. These goods and services are offered for sale on the goods market, where they
are purchased by the households.
The circular flow of income and spending
This diagram shows the interaction between households and firms with the flow of income
and spending.
Firms purchase factors of production in the factor market, this spending by firms represents
the income (wages and salaries, rent, interest and profit) of the households. The households,
in turn, spend their income by purchasing goods and services in the goods market, the
spending by the households represents the income of the firms.
CHAPTER 3: DEMAND, SUPPLY AND PRICES
Demand and supply are the most important (and useful) tools in the economist’s toolkit.
The households are the driving force behind the demand for consumer goods and services,
whereas the firms are the driving force behind the supply of goods and services.
Demand and supply: introduction
In a market economy, the prices and quantities traded in the goods markets are determined
by the interaction of demand and supply.
Demand

If you demand something, it means that you intend to buy it and that you have the
means (the purchasing power) to do so.

A ‘want’ is not a demand (wanting something without intending to or having the
means to buy it is not demand).

Demand is a flow concept- measured over a period (e.g. day, week, month, quarter or
year).

It relates to the plans of households, firms and other participants in the economy, not
to events that have already occurred.

Quality bought is different from quantity demanded, quantity purchased will depend
on the availability of the goods or service in question, quantity demanded will depend
on the goods and services that a potential buyer is willing and able to purchase.

For example: a potential consumer can go to Spar willing and able to purchase milk
and bread (quantity demanded), but end up purchasing milk, bread and sugar or bread
only if the milk is not available at Spar (quantity bought/ exchanged).

The example then proves that quantity demanded may be less than, equal to or
greater than the quantity actually bought.

Demand can be expressed in words, schedule (or numbers), curves (or graphs) and
equations (or symbols).
Market demand
What determines the quantity of a good that the households plan to purchase in a particular
period:
o The price of the product.
o The prices of related products.
o The taste (or preference) of the consumers.
o The number of households
Factors that determine quantity purchased and not demanded:
o The availability/supply of the product- because they plan and are willing to buy the
product, but due to its availability in the store they buy it (if it’s available) or they don’t
buy it (if it’s unavailable). This influence purchased units for the product.
The quantity of a good demanded in a particular period depends on the price of the good, the
price of related goods, the income of the households, consumer’s taste, number of
households and any other possible influence.
This statement in symbols instead of words:
Qd = quantity of goods demanded
PX= price of a good
Pg= prices of related goods (complements or substitutes goods)
Y= households’ income during the period
T= taste of the consumers concerned
N= number of consumers in the market concerned
…= allowance for other possible influences
Then, we can also express the individual’s demand for the x good as: Qd = f (PX, Pg, Y, T, N, …).
Qd is the dependent variable, and all other variables are independent variables (before any
quantity is demanded potential buyers first consider the independent variable).
The law of demand states that: the higher the price of a good, the lower the quantity
demanded and the lower the price of a good, the higher the quantity demanded.
Relationship between quantity demanded and price, illustrated using demand schedule and
demand curve.
Demand curve is line DD which joins the points on the graph
Demand curve is line DD which joins the points on the graph. The negative slope of the curve
clearly indicates that the quantity demanded increases as the price decreases.
The demand curve shows the relationship between the quantity of tomatoes demanded
weekly and the price of tomatoes, on the assumption that all other things remain equal.
Qd = f (PX, Pg, Y, T, N, …)
Pg, Y, T, N (have bars above them) indicate that these variables or determinants are held
constant. Therefore:
Qd = f (PX)
Movements along the demand curve and shift of the curve
The movement along the curve relates to the slope of the curve, while the shift of a curve
relates to its position or intercept.
Movements along the demand curve:



A change in price represents a movement along the demand curve. E.g. a fall from R50
per kg to R40 per kg.
If price should change it would change the quantity demanded of the good (a
movement along the demand curve).
The market demand curve shows the relationship between the price of the product
and the quantity demanded.
A shift of the demand curve:



A change in demand represents a shift of the demand curve.
A change in any of the determinants of demand other than the price of the product
will shift the demand curve.
Changes in the other determinants of demand are reflected only as the shift of the
curve itself. This is described as a change in demand.
Changes in other determinants of demand, which cause the demand curve to shift:

A change in the price of the related good
The quantity of goods that consumers or households plan to buy does not depend only
on the price of that good,
substitute e.g. butter and margarine, tea and coffee, apples and pears.
If the price of butter increases, a greater quantity of margarine will be demanded at
each price of margarine than before. (the demand curve for margarine will therefore
shift to the right, this is called an increase in demand). If the price of butter decreases
the opposite will occur.
Complements e.g. fish and ships, motorcars and petrol, coffee and milk, spaghetti and
meatballs, tomatoes and onion, tomatoes and lettuce, golf clubs and golf balls.
If the price of the complement of a good changes, the demand for the good will also
change. (a decrease in the price of a complementary product increases the demand
for the product concerned, this is illustrated by a rightward shift of the demand curve).
An increase in the price of the complement product (Xbox consoles) will lead to a
decrease in the demand for the product (Xbox games).

A change in the income of consumers
An increase in income will normally lead to an increase in demand, while a fall in
income will result in a decrease in demand.
An increase in income will shift demand curve for normal good to the right, a decrease
in income will shift the demand curve for a normal good to the left.
An increase in income will shift the demand curve for an inferior good to the left, a
decrease in income will shift the demand curve for an inferior good to the right.

A change in consumers’ tastes or preferences
When consumers’ tastes or preferences change, demand changes.
The demand curve shift to the left when the demand of a product falls and to the right
when the demand of a product increases.

A change in population
Demand also depends on the size of the population served by the market- the larger
the population, the greater the demand; the smaller the population, the smaller the
demand.
An increase the population will thus shift the demand curve to the right, a decrease in
the population will shift the demand curve to the left.

Other influences on demand
A change in expected future prices- if the price of a good is expected to fall, consumers
will tend to reduce their current demand, preferring to wait and buy more later at a
lower price. Ceteris paribus.
The distribution of income- if income is redistributed from high-income households to
low-income households, the demand for goods bought mostly by low-income
households will increase while the demand for goods purchased mostly by highincome households will decrease.
Along demand curve DD, a movement from a to b indicates a decrease in the quantity
demanded, while from a to c shows an increase in quantity demanded.
An increase in demand is represented by a rightward shift of the demand curve, such
as the shift from DD to D2D2. A decrease in demand is represented by a leftward shift
of the demand curve, such as the shift from DD to D1D1.
Supply




Supply can be defined as the quantities of a good or service that producers plan to sell
at each possible price during a certain period.
Supply is also a flow concept- measured over a period of time (hour, day, week, month,
etc).
Producers must be willing and able to supply the quantities concerned (there is no
guarantee that the quantity supplied will actually be sold).
Supply can be expressed in four ways: using words, using numbers (the supply
schedule), using graphs (the supply curve), using symbols (the supply equation).
Qs = f (PX, Pg, Pf, Pe, Ty, N, …) QS = f(PX)
Market supply
Market supply is the combined result of the decisions of all the individual suppliers of the
product in question.
What determines the supply of the product (e.g. tomatoes) in a particular year?
o The price of the product- the higher the price of the product, the greater the quantity
that farmers will plan to grow and sell, ceteris paribus.
o The price of alternative products
o Prices of factors of production and other inputs- an increase in any input, result in a
decrease in the quantity of the product supplied.
o Expected future prices
o The state of technology- new technologies that enable producers to produce at lower
costs will increase the quantity supplied at each price.
The quantity of a good supplied in a particular period is a function of the price of the good,
the prices of alternative outputs, the prices of the factors of production, the expected future
prices of the good and the state of technology.
Qs = f (PX, Pg, Pf, Pe, Ty, N, …)
Other influences include natural disasters, complementary products, government policy,
productivity.
Supply schedule- shows the various quantities of tomatoes that farmers will supply at various
prices during a particular week.
Supply curve- indicates the relationship between the quantity of tomatoes supplied weekly
and the price of tomatoes, on the assumption that all other things remain unchanged. It is
formed when the points are joined with SS.
it has a positive slope, indicating that the quantity supplied increases as the price increase.
Movements along the supply curve and the shifts of the curve
Movement along the supply curve
-A change in the price of the product leads to a movement along the supply curve SS.
-Any increase or decrease in the price of the good leads to an increase or decrease
respectively, in the quantity supplied of the good.
Shift of the curve
-Any of the other factors that affect supply, would cause supply to increase or decrease- the
shifting of the entire supply curve.
-An increase in supply would cause a rightward shift while a decrease would cause a leftward
shift of the supply curve.
Market equilibrium
Market equilibrium occurs when the quantity demanded is equal to the quantity supplied.
This happens when the plans of the households coincide with the plans of the firms, the price
at which this occurs is called the equilibrium price. Qd = Qs
When the quantity demanded is greater than the quantity supplied, there is excess demand
(market shortage) at that particular price. When the quantity supplied is greater than the
quantity demanded, there is excess supply (market surplus).
Consumer surplus and producer surplus
The equilibrium or market-clearing is determined by the interaction between demand and
supply.
With a downward sloping demand curve and upward sloping supply curve, it means that some
consumers are paying less than the maximum they would be willing to pay while some
producers are receiving more than what they are willing to produce at.
Consumer surplus



This occurs when the market price is usually lower than the highest prices consumers
are willing to pay for all but the last unit of the product concerned.
The demand curve (DD) indicates the highest prices that consumers are willing and
able to pay for different quantities of the goods.
If the market price is P1, then for all quantities up to Q1, consumers are willing to pay
more than P1.
The shaded area represents a gain to consumers. For each quantity between 0 and Q1 (except
Q1) consumers are willing to pay more than the P1.
Producer surplus



Involves the idea of producers being willing to supply units of the product at less than
the market price.
The supply curve (SS) indicates the different quantities that producers are willing to
supply at different prices.
If the market price is P1, then for all quantities up to Q1, producers are willing to
produce at a lower price.
The shaded area represents a gain to producers.
Consumer surplus and producer surplus at market equilibrium
o At equilibrium price, the sum of the consumer and producer surplus is maximised.
CHAPTER 4: DEMAND AND SUPPLY IN ACTION
A change in any determinants of demand and supply (The price of alternative products, price
of factors of production, expected future prices, the state of technology) except the price of
the product will cause a change in demand or supply, this is illustrated by a shift of the demand
curve or the supply curve.
Here we examine the impact of demand or supply (not quantity demanded or supplied).
Changes in demand
An increase in demand will result in an increase in the price of the product and an increase in
the quantity exchanged. A decrease in demand will result in a decrease in the price of the
product and a decrease in the quantity exchanged.
The sources of an increase in demand include:
o
o
o
o
o
An increase in the price of a substitute product
A decrease in the price of a complementary product
An increase in consumers’ income
A greater consumer preference for the product
An expected increase in the price of the product
When demand increases, supply remains unchanged, but the quantity supplied increases as
the price of the product increases.
The decrease in demand could be the result of a change in any of the determinants of demand
except for price of the product:
o
o
o
o
o
A fall in the price of a substitute product
An increase in the price of a complementary product
A fall in consumers’ income
A reduced preference for the product
An expected fall in the price of the product
Changes in supply
An increase in supply will result in a fall in the price of the product and an increase in the
quantity exchanged. A decrease in supply will result in an increase in the price of the product
and a decrease in the quantity exchanged. A decrease in supply means that fewer goods are
supplied at each price than before or, alternatively, that each quantity is supplied at a higher
price than before.
The sources of an increase in supply include:
o A fall in the price of an alternative product or rise in the price of a joint product.
o A reduction in the price of any of the factors of production or other inputs
o An improvement in the productivity of the factors of production.
When supply increases, demand remains unchanged, but the quantity demanded increases
as the price of the product falls.
The decrease in supply could be the result of a change in any of the determinants of supply
other than the price of the product:
o An increase in the price of an alternative product or a fall in the price of a joint product.
o An increase in the price of any factors of production or other inputs
o A deterioration in the productivity of the factors of production.
Simultaneous changes in demand and supply
When one factor changes, it is usually possible to predict the effects of such change compared
to when more than one factors change.
The results of the various combinations of simultaneous changes in demand and supply.
Interaction between related markets
When consumers like meat more than fish, there will be a decrease in the demand of the fish
(leftward shift of the curve) and an increase in the demand of the meat (rightward shift of the
curve), this is due to change in consumers’ taste.
When the cost of producing motorcars increase, the demand for motorcars and tyres will
decrease while supply for motorcars increases, this is due to an increase in the price of joint
products.
Government intervention
The government intervention can take different forms, including:




Setting maximum prices (price ceilings)
Setting minimum prices (price floors)
Subsidising certain products or activities
Taxing certain products or activities
Maximum prices
Government set maximum prices to:
o
o
o
o
Keep the prices of basic foodstuffs low, as part of a policy to assist the poor.
Avoid the exploitation of consumers by producers, that is, to avoid unfair prices.
Combat inflation
Limit the production of certain goods and services.
When the maximum price is set below the equilibrium price, it will have significant effects.
This is when market shortage (excess demand) occurs.
The welfare costs of maximum price fixing
Rectangle B is transferred from the producer surplus to the consumer surplus.
Triangle A and C both disappears. The total deadweight loss to society is equal to A plus C. Too
little is being produced, and in the end society is worse off of the interference in the market.
Minimum prices
If the minimum price is below the ruling equilibrium price, the operation of market forces is
not disturbed; but if the minimum price is above the ruling equilibrium price there is a market
surplus (excess supply).
The welfare costs of minimum price fixing
Rectangle A is transferred from the consumer surplus to the producer surplus.
Triangle C and B, both disappear. The total dead weight loss to society is equal to B plus C.
Subsidising certain products or activities
Suppose the government wants to lower the price to the consumers and increase production
by subsidising (assisting) the producers.
Taxes
We now examine the impact of specific taxes (e.g. the taxes on cigarettes, alcohol beverages
and fuel) and who will bear the burden of the tax. When government impose tax on
manufacturer they attempt to pass the tax to consumers (by including tax on the price of the
product), but the extent to which they are able to do so is limited by the demand and supply
of the product.
The burden of an excise tax is actually shared by three groups:



The consumers
The suppliers
The employees of the suppliers
Welfare implications of a specific excise tax