Principles of Economics: Supply, Demand, and Government Policies

Price Controls

Policies enacted by policymakers to regulate the price of goods or services in the market.

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.

Binding Price Ceiling

A price ceiling that is set below the equilibrium price, causing a shortage.

Not Binding Price Ceiling

A price ceiling that is set above the equilibrium price, having no effect on the market.

Shortage

A situation where the quantity demanded exceeds the quantity supplied at a given price.

Surplus

A situation where the quantity supplied exceeds the quantity demanded at a given price.

Rationing Mechanism

The method by which scarce goods are allocated among potential buyers.

Equilibrium Price

The price at which the quantity supplied equals the quantity demanded.

Labor Supply Determinant

Factors that influence the supply of labor in the market.

Tax Incidence

The distribution of the tax burden between consumers and producers.

Elasticity

A measure of how much the quantity demanded or supplied of a good responds to changes in price.

Minimum Wage Laws

Legislation that sets the lowest legal wage that can be paid to workers.

Rent-Control Laws

Regulations that limit the amount landlords can charge for renting out a home or apartment.

Active Learning 1: Price Ceilings for Muffins

An example scenario analyzing the effects of price ceilings on muffin prices.

Market Price

The price at which goods are bought and sold in a competitive market.

Quantity Demanded (Qd)

The total amount of a good that consumers are willing to purchase at a given price.

Quantity Supplied (Qs)

The total amount of a good that producers are willing to sell at a given price.

Unintended Consequences of Rent Control

Negative effects that arise from implementing rent control policies.

Price Ceiling Example

A price ceiling set at $2 creates a shortage of 8 muffins.

Price Ceiling Not Binding Example

A price ceiling set at $5 has no effect because it is above the equilibrium price.

Market Equilibrium

The point where supply and demand curves intersect, determining the market price and quantity.

Inefficiency of Rationing

Rationing mechanisms can lead to inefficiencies where goods do not go to the buyers who value them most.

Long Lines as Rationing

Long lines for goods can waste buyers' time and indicate a shortage.

Quantity Demanded

The total amount of a good that consumers are willing to purchase at a given price.

Quantity Supplied

The total amount of a good that producers are willing to sell at a given price.

Gasoline Shortage

The difference between quantity demanded and quantity supplied, QD - QS.

Rent Control

Local ordinances that limit rent increases for some rental housing units, positively impacting affordable rental housing.

Short-Run Effects of Rent Control

Causes only a small shortage of housing due to relatively inelastic supply and demand curves.

Long-Run Effects of Rent Control

Causes a larger shortage of housing due to more elastic supply and demand curves.

Not Binding Price Floor

Set below the equilibrium price, having no effect on price or quantity sold.

Binding Price Floor

Set above the equilibrium price, resulting in some sellers being unable to sell what they want.

Current US Federal Minimum Wage

The minimum wage set at $7.25 per hour.

Binding Minimum Wage

A price floor that causes a surplus in the labor market, leading to unemployment.

Muffin Price Floor

A price floor set at $1 is not binding; a price floor set at $4 is binding, resulting in a surplus of 8 muffins.

Rent Subsidy

A financial assistance program aimed at helping individuals afford housing costs.

Wage Subsidy

A government incentive to increase the income of low-wage workers, such as the earned income tax credit.

Economic Activity Organization

Markets are usually a good way to organize economic activity, balancing supply and demand.

Government Motivation for Price Control

Governments may control prices when they view market outcomes as unfair.

Taxes discourage market activity

Taxes lead to a reduction in the quantity sold in the market.

Quantity sold in new equilibrium

The quantity sold is smaller after a tax is imposed.

Tax burden sharing

Both buyers and sellers share the tax burden, with buyers paying more and sellers receiving less.

Sellers send tax money to government

Sellers are responsible for sending the collected tax amount to the government.

Tax on Sellers

When a tax of $0.50 is levied on sellers, the supply curve shifts up by $0.50.

Equilibrium quantity with tax on sellers

The equilibrium quantity falls from 100 to 90 cones when a tax is imposed.

Price buyers pay after tax on sellers

The price that buyers pay rises from $3.00 to $3.30 due to the tax.

Price sellers receive after tax on sellers

The price that sellers receive falls from $3.00 to $2.80 after paying the tax.

Tax on Buyers

When a tax of $0.50 is imposed on buyers, the demand curve shifts down by $0.50.

Equilibrium quantity with tax on buyers

The equilibrium quantity falls from 100 to 90 cones when a tax is imposed on buyers.

Price sellers receive after tax on buyers

The price that sellers receive falls from $3.00 to $2.80 due to the tax on buyers.

Price buyers pay after tax on buyers

The price that buyers pay rises from $3.00 to $3.30 when a tax is imposed.

Wedge created by tax

A tax creates a wedge between the price that buyers pay and the price that sellers receive.

Elasticity and Tax Incidence

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

Elasticity of demand

A small elasticity of demand indicates that buyers have few alternatives to the good.

Elasticity of supply

A small elasticity of supply indicates that sellers have few alternatives to producing the good.

Tax burden distribution

The side of the market less willing to leave bears more of the tax burden.

Elastic supply and inelastic demand

When supply is elastic and demand is inelastic, buyers bear most of the tax burden.

Inelastic supply and elastic demand

When supply is inelastic and demand is elastic, sellers bear most of the tax burden.

Price burden division (elastic supply)

In this case, the price received by sellers falls slightly while the price paid by buyers rises substantially.

Price burden division (inelastic supply)

In this case, the price received by sellers falls substantially while the price paid by buyers rises only slightly.

Conclusion on price controls and taxes

Price controls and taxes are common in markets and their effects are often debated.

Supply and demand analysis

Supply and demand are the first and most useful tools for analyzing government policies.