Chapter 6 Supply Demand and Government Policies Controls on Prices Price ceiling a legal maximum on the price at which a good can be sold Price floor a legal minimum on the price at which a good can be sold How price ceilings affect market outcomes o 1 If the equilibrium price is below the price ceiling the price ceiling is not binding market forces will naturally move the economy to the equilibrium and the price ceiling has no effect on the price of the good o 2 If the equilibrium price is above the price ceiling the price ceiling is a binding restraint on the market the forces of supply and demand tend to move the price towards the equilibrium but once the market price hits the price ceiling it by law can not raise any higher at this price there is a shortage ex demand 125 cones supply 75 cones 50 ppl cant buy ice cream Even though a price ceiling was meant to lower prices for the buyers in the end some buyers are left without ice cream or have to wait in long lines to get ice cream o When the government imposes a binding price ceiling on a competitive market a shortage of the good arises and sellers must ration the scarce goods among the large number of potential buyers o Ex gas and rent control How price floors affect market outcomes o 1 If the equilibrium price is above the price floor then the price floor is not binding market forces naturally move the economy to the equilibrium the price floor has no effect o 2 If the equilibrium price is below the price floor then the price floor is binding market forces tend to move towards the equilibrium price but when it hits the price floor it can t drop anymore there is a surplus ex 120 cones supplied 80 demanded some sellers cant sell ice cream o Ex minimum wage Evaluating price controls o One of the 10 principles states that markets are a good way to organize economic activity gov interference obscures the signals that normally guide the market o Another principle states that gov can sometimes improve market outcomes however rent control may keep rent low but it discourages landlords from maintaining their buildings and makes housing hard to find minimum wage laws may raise the incomes of some but also causes unemployment Taxes Tax incidence the manner in which the burden of a tax is shared among participants in a market How taxes on sellers affect market outcomes o Decide whether the law affects the supply or demand curve decide which way the curve shifts examine how the shift affects the equilibrium price and quantity o Supply curve shifts to the left decrease while demand curve stays the same o Equilibrium price rises and quantity falls sellers sell less buyers buy less so the tax reduces the size of the market o Tax makes buyers and sellers worse off o Summary taxes discourage market activity when a good is taxes the quantity of the good sold is smaller in the new equilibrium buyers sellers share the burden of taxes in the new equilibrium buyers pay more for a good and sellers receive less How taxes on buyers affect market outcomes o Demand curve shifts to the left decrease while supply curve stays o Equilibrium price and quantity fall o Tax reduces the size of the market buyers and sellers share the the same burden Taxes levied on sellers and taxes levied on buyers are equivalent Ex payroll tax Elasticity and taxes o When the supply curve is elastic and the demand curve is inelastic the price received by sellers falls only slightly while the price paid by buyers rises substantially o When the supply curve is inelastic and the demand curve is elastic the price received by sellers falls substantially while the price paid by buyers rises only slightly o A tax burden falls more heavily on the side of the market that is less elastic o Ex luxury tax o Tax incidence depends on elasticity most of the burden falls on the side of the market that is less elastic b c that side of the market can respond less easily to the tax by changing the quantity sold or bought
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