Chapter 6 - SUPPLY, DEMAND AND, GOVERNMENT POLICIES

What is a price ceiling?

The legal maximum price a seller is allowed to charge.
Think: “You can’t go above this price.”

👉 Example: Rent control laws (landlords can’t charge more than a set rent)

What is a price floor?

The legal minimum price a seller is allowed to charge.
Think: “You can’t go below this price.”

👉 Example: Minimum wage (workers must be paid at least this amount)

What happens when the is a price ceiling is below equilibrium? For consumers and producers?

If the ceiling is too low, it causes a shortage.

👉 Why?

• More people want the product (it’s cheap)

• Sellers don’t want to sell as much

📌 Result: Not enough goods for everyone

What happens when the price floor is above equilibrium? For consumers and producers?

If the floor is too high, it causes a surplus.

👉 Why?

• Sellers want to sell more (high price)

• Buyers don’t want to buy as much

📌 Result: Too much of the product, not enough buyers

Is price ceiling supposed to be above or below equilibrium?

Above

Is price floor supposed to be above or below equilibrium?

Below

What is a tax?

A tax is money the government takes when people buy or sell something.

👉 Example: Sales tax when you buy clothes

How do taxes affect the market? How does it affect buyers and sellers?

Taxes make things more expensive and reduce buying and selling.

👉 What happens:

• Buyers pay more 💸

• Sellers receive less 💸

• Fewer products are sold

Does it matter if the tax is on buyers or sellers? What happened if tax is on buyers? What happens if tax is on sellers?

Not really!

👉 Even if:

• Tax is on buyers → prices go up

• Tax is on sellers → prices still go up

📌 Both end up sharing the cost

What is tax incidence?

who actually feels the burden of the tax

👉 In simple terms:
Who is really paying more money?

What determines who pays more of the tax?

It depends on who can change their behavior more easily.

👉 If buyers really need something (like gas):

• Buyers pay more of the tax

👉 If sellers really need to sell:

• Sellers pay more of the tax

📌 Rule:
The side that can’t avoid the tax easily pays more

Simple real-life example of tax incidence

Gas tax ⛽

• People still need gas → they keep buying

• So buyers pay most of the tax

What does this graph show?

Equilibrium without price controls

What does the red line represent?

Price ceiling

A price ceiling above the equilibrium price is… binding or not binding? Does it have a effect on the market outcome?

Not Binding

Has no effect on the market outcome

If the equilibrium price is above the ceiling, would it be legal or illegal? and would it be binding or not binding? Surplus or Shortage?

• Illegal

• Binding

• Shortage

If there is a shortage, how would sellers “ration” goods? Or decides who gets the limited items? (Rationing Methods)

• Long Lines: first come first served, it wastes time because not everyone can wait

• Discrimination (bias) : sellers choose based on personal preference, its unfair and not based on who actually needs it the most

Main Idea: Shortages cause unfair rationing, so goods don’t always go to the people who value them most.

Is this binding? Does it have an effect on the market outcome?

• Not Binding

• Has no effect on the market outcome

Is this binding or not binding? Does it cause a surplus or shortage? Is it legal or illegal?

• Binding

• Causes a Surplus

• Illegal

Determine the effects of $90 price ceiling. Shortage or surplus by how much? Binding or not binding?

• Binding price ceiling below the equilibrium

• The price falls to $90.

• Shortage of 30

Determine the effects of $90 price floor

• Equilibrium price is above the $90 price floor, so the price is not binding

• P= $100

• Q= 100 rooms

Determine the effects of $120 price floor

• Binding price floor above the equilibrium

• Buyers demand 60 rooms, sellers supply 120

• Surplus

What is a market?

buyers + sellers interacting

Why do economists usually oppose price ceilings and price floors?

They interfere with the market’s natural balance

Prices in a market economy are best described as:

Determined by supply and demand

What is the main role of prices in a market?

To balance supply and demand

What does it mean that markets “coordinate economic activity”?

Buyers and sellers make decisions based on prices

Why do governments use price controls?

To help poor people and fix unfair markets

What is a major problem with price controls?

They often hurt the people they are trying to help

Which is a better way to help low-income individuals?

Subsidies

A rent subsidy is:

Government help paying rent

Why does the government use taxes?

👉 To raise money for important things like:

• 🛣 Roads

• 🏫 Schools

• 🪖 National defense

➡ Basically: public services

Who does the government tax?

• Buyers (customers)

• Sellers (businesses)

How is the tax burden shared between buyers and sellers?

• Buyers usually pay higher prices

• Sellers usually receive less money

New equilibrium with tax:

Sellers receive:

Buyers Pay:

Total tax:

• 450

• $9.50

• $11.00

• $1.50 tax

How much more do buyers pay? How much less do sellers get due to tax?

• Buyers pay $1.00 more

• Sellers get $0.50 less

Would a tax on buyers shift the demand curve up or down?

Down

👉 Why?

• Buyers now have to pay extra (the tax)

• So they are less willing to buy at every price

Buyers pay $1.50 more than market price

Would a tax on sellers shift the supply curve up or down?

It shifts the supply curve up.

Tax on sellers = they need more money to make the same amount with the tax

Suppose the government imposes a tax on buyers of $30 per room.

What’s the new equilibrium, Buyers price, and sellers price?

New Equilibrium: 80

Buyers Price: $110

Sellers Price: $80

What’s the incidence on buyers and sellers?

• Buyers: $10

• Sellers: $20

What happens when supply is more elastic than demand?

Supply is more elastic → sellers can easily stop selling if prices aren’t good.

Demand is less inelastic → buyers can’t stop buying what they need.

• Think of it like a balloon: sellers can let go of the balloon (leave the market) easily, but buyers are holding onto it tightly (need the product). The “tight grip” (buyers) ends up taking most of the weight of the tax.

Buyers pay more tax!

What happens when demand is more elastic than supply?

Demand is more elastic → buyers can easily stop buying if the price goes up.

Supply is less elastic → sellers can’t easily stop selling.

• Imagine a balloon again: this time, buyers are holding the balloon loosely (they can let go) and sellers are holding tightly (they can’t let go). The “tight grip” (sellers) ends up taking most of the weight of the tax.

Sellers pay more tax!

What is luxury tax?

• In 1990, Congress added a tax on very expensive things like:

  • Yachts, Private airplanes, Furs, Jewelry, Expensive cars

• The idea: make rich people pay extra money because they can afford it.

Who ends up paying the tax?

Sellers

Demand is elastic, supply is inelastic

• Because buyers (rich people) can easily avoid the tax by not buying, they don’t pay most of it.

• Sellers can’t easily leave the market, so they end up losing money or lowering their prices to sell.