Lesson 7 Microeconomics

Market equilibrium

Efficient when social cost equals social benefit

Price ceiling

A regulation that makes it illegal to charge a price higher than a specified amount.

Price ceiling set above the equilibrium price

No effect.

Price ceiling below the equilibrium price

Powerful effects on a market.

Rent ceiling

Price ceiling imposed in a housing market. Prohibits charging rent that exceeds the ceiling amount. Alter the market’s behavior to supply shock.

Existence of a shortage leads to

Search activity and black markets.

Search activity

Time spent looking for someone with whom to do business.

When a price is regulated and there is a shortage

Search activity increases

Black markets

An illegal market in which the price exceeds the legally imposed price ceiling

Price ceilings create

Inefficiency and a deadweight loss.

Price floor

A regulation that makes it illegal to buy or sell at a price lower than the specified level

Price floor set below the equilibrium price

No effect. The reason is that the ___ does not constrain the market focus. The force of the law and the market forces are not in confilict.

Price floor set above the equilibrium price

Powerful effects on a market. The reason is that the __- attempts to preent the price from regulating the quantities demanded and supplied. The force of the law and the market forces are in conflict.

Minimum wage law

A price floor that makes hiring workers for less than the specified wage rate illegal.

Wage rate above the equilibrium wage

The quantity of labor supplied exceeds the quantity of labor demanded—there is a surplus of labor. When a minimum wage is set above the equilibrium wage, there is a surplus of labor. The demand for labor determines the level of employment, and the surplus of labor is unemployed.

Tax incidence

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

Rent ceiling set below the equilibrium rent

Results in an inefficient underproduction of housing services. Marginal social benefit of housing exceeds its marginal social cost and a deadweight loss shrinks the producer surplus and consumer surplus.

If a minimum wage is set above the equilibrium wage rate

The quantity of labor is demanded is less than the quantity of labor supplied. This surplus of labor is unemployed workers.

In a regulated labor market, when the demand for labor decreases

Minimum wage laws create lower employment and create unemployment

Most economists believe

Minimum wage laws contribute to higher unemployment among low-skilled young workers.

Minimum wage laws create

Economic inefficiency. They result in unemployment and excessive job search

Sales tax

Decreases the supply of the taxed good, so the supply curve shifts leftward.

Vertical distance between the supply curve and the tax and without it equals

The amount of the tax. The equilibrium price, including the tax, rises and the equilibrium quantity decreases.

The division of the tax depends on

The elasticities of demand and supply

The more inelastic the demand

The more demanders pay of the tax

Perfectly inelastic demand

Buyers pay all the tax

Perfectly elastic demand

Sellers pay all the tax. The more inelastic the supply, the more sellers pay of the tax.

Perfectly inelastic supply

Sellers pay all the tax

Perfectly elastic supply

Buyers pay all the tax

Usually products with inelastic demands are taxed

Because the tax does not reduce the quantity purchased by as much as taxing goods with elastic demands.

Taxing a good with an inelastic demand results

In more tax revenue and a smaller deadweight loss than taxing a good with an elastic demand

Production quota

An upper limit to the quantity of a good that may be produced in a specific period of time. Will only have an impact if they are set below the equilibrium level of output in a market

Production quota results

In a decrease in supply, a rise in price, a decrease in marginal cost, inefficiency from underproduction, and an incentive to cheat and overproduce. Occurs when it is set below the equilibrium quantity.

Subsidy

A payment made by the government to a producer. Increases the supply.

Subsidy results

In an increase in supply, a fall in price and increase in quantity produced, an increase in marginal cost, payment to producers by the government, and inefficiency from overproduction

The harm from rent ceilings

Whenever some influence disturbs an equilibrium in an

unregulated (free) market, the differing desires of buyers and sellers are brought back into

balance by price movements. If prices are controlled by government regulation, however,

the price mechanism no longer can serve this purpose. In the case of price ceilings,

increased search activity will emerge.

By creating increased searched

Price ceilings waste society’s scarce resources.

If the demand for the product is very elastic

Consumers can find good substitutes for the product being taxed. So, if sellers tried to stick demanders with a large part of the tax, buyers would substitute other products, and suppliers would find themselves unable to sell anything. In this case, suppliers absorb a large portion of the tax.

If the demand for a good is inelastic

Consumers cannot readily find anything to take the product’s place. In this situation, consumers pay a large part of the tax.

If supply is very elastic

Suppliers can find other products to produce and so buyers wind up paying most of the tax.

If supply is inelastic

Producers cannot easily switch to producing another product. Buyers do not have to pay much in this case because suppliers can’t find anything else to produce.

Tax incidence

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

When the government imposes a tax on the sale of a good

The price paid by buyers might rise by the full amount of the tax, by a lesser amount, or not at all.

If the price paid by buyers rises by the full amount of the tax

The burden of the tax falls entirely on buyers—the buyers pay the tax.

If the price paid by buyers rises by a lesser amount than the tax

The burden of the tax falls partly on buyers and partly on sellers.

If the prices paid by buyers doesn’t change at all

The burden of the tax falls entirely on sellers.

Tax incidence does not depend on

The tax law. The law might impose a tax on sellers or on buyers, but the outcome is the same in either case.

Two conflicting principles of fairness to apply to a tax system

The benefits principle and the ability-to-pay principle.

Benefits principle

The proposition that people should pay taxes equal to the benefits they receive from the services provided by the government. Fair because it means that those who benefit most pay the most taxes.

Ability-to-pay principle

The proposition that people should pay taxes according to how easily they can bear the burden of the tax.

Consequences of a minimum wage

A surplus of labor, increased search activity.

Consequences of rent ceilings

A shortage of apartments, increased search activity, less incentives for owners to maintain buildings, hidden costs of renting, and who gets to benefit?

Irrelevant, important

For most employees, the minimum wage is ___. It is though particularly ___ for young people.

Why might labor unions support raising the minimum wage, despite earning well more than the minimum and proposed increases

Union workers compete with non-union workers who often earn the minimum wage. This reduces the cost of union workers, relative to non-union.

Taxes

A tool the government can use to generate resources to use for their own ends. Creates an inefficiency in markets.

Examples of per unit sales taxes

Gasoline, cigarettes, alcohol, rental cars, hotel rooms, and airline.

Sales taxes are typically collected

By sellers and remitted to the government.