Eco 101 Chapter 6

Supply, Demand, and Government Policies

Price Controls

Economists as policy analysts and advisers try to use theories to change the world

Policymakers often enact price controls when they believe that the market price of a good or service is too high or too low

These policies can generate problems of their own

Price Ceiling

A legal maximum on the price at which a good can be sold (rent control laws)

Price Floor

A legal minimum on the price at which a good ca be sold (Maximum wage laws)

How Price Ceilings Affect Market Outcomes

Not binding: Set above the equilibrium price and has no effect on price or quantity sold

Binding constraint: Set below the equilibrium price and market price must be the price ceiling

Binding Price Ceiling

When the government imposes a binding price ceiling, shortages arise and sellers must ration scarce goods among potential buyers

Rationing mechanisms are rarely desirable

How Price Floors Affect Market Outcomes

Not binding: Set below the equilibrium price and has no effect in price or quantity sold

Binding constraint: Set above the equilibrium price and some sellers are unable to sell what they want

Binding Price Floor

When the government imposes a binding price ceiling, surpluses arise, sellers who appeal to the buyers personal biases may be better able to sell their goods than those who do not

Evaluating Price Controls

Markets are usually a good way to organize economic activity

Governments can sometimes improve market outcomes

Price controls can hurt some people they are intended to help

Taxes

Governments use taxes to raise revenue for public projects

Tax Incidence

Manner in which the burden of a tax is shared among participants in a market

Taxes on sellers and taxes on buyers are equivalent

How Taxes on Sellers Affect Market Outcomes

Taxes discourage market activity

Buyers and sellers share the tax burden

How Taxes on Buyers Affect Market Outcomes

Buyers pay a lower market price but effect price (with tax) rises

Elasticity and Tax Incidence

Tax burden falls more heavily on the side of the market that is less elastic

Elastic supply, inelastic demand: Price received by sellers doesn’t fall much, price paid by buyers rises substantially, and buyers bear most of the tax burden

Inelastic supply, elastic demand: Price paid by buyer doesn’t rise much, price received by sellers falls substantially, and sellers bear most of the box