Principles of Microeconomics Chapter 6 Price controls are usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers Price ceiling a legal maximum on the price at which a good can be Price floor a legal minimum on the price at which a good can be sold sold Price Ceilings When the price ceiling is above the equilibrium price it is not binding It has no effect on price or quantity sold When the price ceiling is below the equilibrium price it is a binding constraint Price cannot rise higher resulting in a shortage When the government imposes a binding price ceiling on a competitive market a shortage of the good arises and sellers must ration the goods among the large number of potential buyers rationing mechanisms are unfair and inefficient a free market rations goods with prices Ex Rent control goal to make housing more affordable to the poor But is highly inefficient In the long run the buyers and sellers of rental housing respond more to market conditions as time passes Landlords respond to low rents by not building more apartments and failing to maintain existing ones Buyers are encouraged to find their own apartments and more people move to the city Supply and demand become more elastic Price Floors When the price floor is below the equilibrium price it is not binding It has no effect on price or quantity sold When the price floor is above the equilibrium price it is a binding constraint Price cannot fall lower to hit equilibrium resulting in a surplus When the government imposes a binding price floor on a competitive market a surplus of the good arises and sellers are unable to sell all they want sell all they want rationing also unfair plays on biases a free market allows sellers to Governments use price controls because they view the market s outcome as unfair But price controls often hurt those they are trying to help rent control causes poor housing quality and a shortage of housing minimum wage causes unemployment Taxes When the government levies a tax on a good who bears the burden Tax incidence the manner in which the burden of a tax is shared among participants in a market Determining How Taxes on Sellers Affect Market Outcomes 1 Decide whether the law affects supply or demand curve 2 Determine which way the curve shifts 3 Examine how the shift affects equilibrium price and quantity Ex 50 tax on ice cream sellers 1 Tax is not levied on buyers so demand does not change Supply is affected 2 Tax raises cost of production so supply decreases shifting to the left in addition the profit price of any good will be 50 lower therefore the market price must now be 50 higher than that profit to 3 Equilibrium price will rise equilibrium quantity will fall Size of the compensate for the deficit ice cream market will decrease Implications Buyers and sellers share the burden both are worse off Taxes discourage market activity When a good is taxed quantity sold is smaller Buyers and sellers share the burden of taxes In the new equilibrium buyers pay more and sellers receive less Determining How Taxes on Buyers Affect Market Incomes See above steps Ex 50 tax on ice cream buyers 1 Tax impacts demand demand will change 2 Tax makes buying less attractive demand will decrease and shift left in addition price is effectively 50 more to buyers demand a quantity of ice cream as if the market price were 50 more making actual market price 50 lower to make up for the tax 3 Equilibrium price falls equilibrium quantity falls Implications Buyers and sellers share the burden Taxes levied on sellers and taxes levied on buyers are equivalent Payroll tax a tax on the wages that firms pay workers places wedge in between the wage firms pay workers and the wage workers receive Wage received by workers falls wage paid by firms rises Elasticity and Tax Incidence With an elastic supply and inelastic demand the tax burden will fall more heavily on consumers because they have fewer options With an inelastic supply and elastic demand the tax burden will fall more heavily on sellers because they receive much less profit A tax burden falls more heavily on the side of the market that is less elastic due to the unwillingness of buyers or sellers to leave the market when conditions are unfavorable no alternatives
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