TOPIC 6: GOV'T POLICIES

What is a price ceiling?

A legal maximum on the price at which a good can be sold

What is a price floor?

A legal minimum on the price at which a good can be sold

If a price ceiling is set above the equilibrium price, what happens?

- the price ceiling is not binding
- market forces naturally move the economy to eq'm
- price ceiling has no effect on the price or quantity sold

If a price ceiling is set below the equilibrium price in a market, what happens?

- the price ceiling is a binding constraint
- when market price hits ceiling, it can't rise anymore (market price =ceiling)
- shortage occurs

What is an example of price ceilings affecting market outcomes?

- a rent ceiling!
- supply and demand for housing is fairly inelastic, so price ceiling set BELOW eq'm price is causing a small amount of shortage initially
- over the long run, the amount of shortage increases b/c low rent discourage landlord from building new houses/keeping up with the maintenance + encourages people to just buy their own house

If the price floor is set below the equilibrium price, what happens?

- price floor is not binding
- market forces naturally move the economy to eq'm
- price floor has no effect

If the price floor is set above the equilibrium price, what happens?

- price floor is binding constraint
- market price can't be lower than price floor
- creates a surplus

What is a good or service where the # of suppliers is greater than the # of buyers?

labour

What is minimum wage?

a price floor applied to labour

What does minimum wage set above the eq'm wage do?

creates:
- unemployment (surplus of labour)
- large costs on small business
- An inefficient outcome

Do economists recommend price controls? Why or Why not?

- no
- rent control isn't very helpful in helping the poor.. housing vouchers may be better
- minimum wages don't help people who can't find a job... wage subsidies may be better

What is a per unit tax?

a fixed tax on a product, independent of the product's price.

What are the three questions to ask to determine the effects of taxes?

1. Does the tax affect the supply curve or demand curve?
2. Which way does the curve shift?
3. How does the shift affect the equilibrium?

What is tax incidence?

the division of the burden of a tax between buyers and sellers

What do taxes affecting buyers do?

- discourages market activity (quantity sold is smaller in eq'm)
- buyers and sellers share the burden of taxes (buyers pay more, sellers receive less)

Rule of tax burden

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

In a perfectly inelastic demand, what happens with the tax?

buyers pay entire tax
- the market price rises by full amount tax

In perfectly inelastic supply, what happens with the tax?

sellers pay the entire tax
- market price doesn't rise at all

In perfectly elastic supply, what happens with the tax?

Buyers pay the entire tax
- market price rises by the full amount of the tax