Government Intervention: Price Controls, Taxes, and Subsidies in Economics

Price Ceiling

Legal maximum price for a good/service.

Example of Price Ceiling

Rent Control

Goal of Price Ceiling

Help the poor and make goods more affordable.

Non-binding Price Ceiling

Ceiling is above equilibrium → no effect.

Binding Price Ceiling

Ceiling is below equilibrium → shortage.

Short Run Effect of Price Ceiling

Supply & demand inelastic → small shortage, reduced rents.

Long Run Effects of Price Ceiling

Rationing mechanisms (waiting lists, discrimination, bribes), fewer new housing developments, poor maintenance quality.

Critique of Price Ceilings

Inefficient and often hurts those it's meant to help.

Example of Price Ceiling Impact

1973 Gasoline Shortage: OPEC raised crude oil prices → supply of gasoline decreased; U.S. government imposed a price ceiling → created shortage and long lines.

Key Takeaway on Price Ceilings

Binding price ceilings cause shortages.

Price Floor

Legal minimum price for a good/service.

Example of Price Floor

Minimum Wage

Goal of Price Floor

Ensure fair wages or income levels.

Non-binding Price Floor

Floor is below equilibrium → no effect.

Binding Price Floor

Floor is above equilibrium → surplus.

Impact of Binding Price Floor

If above equilibrium wage → unemployment.

Winners of Price Floor

Workers who keep their jobs (higher pay).

Losers of Price Floor

Workers who lose jobs or can't find work.

Teenage Labor Market Impact

Most affected since low skill & experience.

Purpose of Taxes

Raise government revenue for public goods (defense, schools, etc.).

Tax Incidence

How the tax burden is divided between buyers & sellers.

Legal Incidence

Who the law says pays the tax.

Economic Incidence

Who actually bears the cost.

Tax on Sellers

Supply curve shifts left, higher equilibrium price (buyers pay more), lower equilibrium quantity, market size shrinks.

Tax on Buyers

Demand curve shifts left, lower equilibrium price (sellers receive less), lower equilibrium quantity, market size shrinks.

Payroll Tax Example

Firms and workers each pay half by law; in reality, both share the burden unequally depending on elasticity.

Tax Wedge

Difference between what employers pay and workers receive.

Luxury Tax (1990)

Applied to yachts, planes, furs, jewelry, etc.; goal was to make the rich pay more.

Result of Luxury Tax

Demand highly elastic (rich avoided buying), supply relatively inelastic → workers & producers hurt; repealed in 1993.

Subsidies

Opposite of a tax — government pays buyers or sellers.

Example of Subsidy

$0.50 subsidy per ice cream cone.

Effect of Subsidies

Demand curve shifts right, consumers pay less, sellers receive more, quantity sold increases.

Summary of Price Controls

Ceiling: Shortages (rent control, gas); Floor: Surpluses (minimum wage).

Summary of Taxes

Shift supply or demand, create a wedge between buyer & seller prices, burden shared depending on elasticity.

Summary of Subsidies

Encourage consumption/production, increase total quantity traded.