Government Polices Notes Flashcards

These flashcards cover key concepts related to economic policies, such as price floors, price ceilings, taxes, and their effects on market surpluses.

What is a price floor and when is it binding?

A price floor is a minimum legal price set by the government. It is binding (effective) only when it is set above the market equilibrium price, leading to a surplus of the good or service.

What are the market effects of a binding price floor?

A binding price floor leads to:

• A surplus (excess supply) because the quantity supplied exceeds the quantity demanded at the higher mandated price.

• A decrease in the quantity traded as buyers demand less at the higher price.

• Potential deadweight loss due to the inefficiency caused by the reduction in transactions.

How does a binding price floor impact consumer and producer surplus, and deadweight loss?

• Consumer Surplus (CS): Decreases because consumers pay a higher price and buy less.
• Producer Surplus (PS): Increases for producers who manage to sell their goods at the higher price, but some producers may be worse off if they cannot sell their product due to the reduced quantity demanded.
• Deadweight Loss (DWL): Arises from transactions that no longer occur due to the price floor, representing a loss of total surplus (both consumer and producer) for society.

What are common examples of price floors?

Common examples include agricultural price supports (e.g., minimum prices for certain crops) and minimum wage laws (a floor for the price of labor).

What is a price ceiling and when is it binding?

A price ceiling is a maximum legal price set by the government. It is binding (effective) only when it is set below the market equilibrium price, leading to a shortage of the good or service.

What are the market effects of a binding price ceiling?

A binding price ceiling leads to:

• A shortage (excess demand) because the quantity demanded exceeds the quantity supplied at the lower mandated price.
• A decrease in the quantity traded as sellers supply less at the lower price.
• Potential deadweight loss due to the inefficiency caused by the reduction in transactions and often results in non-price rationing mechanisms.

How does a binding price ceiling impact consumer and producer surplus, and deadweight loss?

• Consumer Surplus (CS): Increases for consumers who successfully obtain the product at the lower price, but many consumers who want the product at that price cannot get it.
• Producer Surplus (PS): Decreases significantly as producers receive a lower price and sell less.
• Deadweight Loss (DWL): Arises from transactions that no longer occur due to the price ceiling, representing a loss of total surplus from the market not being able to clear efficiently.

What is a common example of a price ceiling?

Rent control is a typical example of a price ceiling, where a maximum price is set for rental housing, often leading to housing shortages.

What is deadweight loss in the context of market inefficiencies?

Deadweight loss is the reduction in total surplus (the sum of consumer and producer surplus) that results from a market distortion, such as a tax or a price control. It signifies the economic inefficiency or the net benefit lost to society because transactions that would have occurred in an efficient market no longer take place.

How do taxes affect the supply curve and market equilibrium?

When a tax is imposed on producers, it increases their cost of production. This causes the supply curve to shift vertically upwards by the amount of the tax, or equivalently, to the left. This leads to a higher equilibrium price for consumers and a lower quantity traded in the market.

What is tax incidence and how is it determined by elasticity?

Tax incidence refers to the actual burden of a tax, indicating who ultimately pays the tax (buyers or sellers) regardless of who is legally responsible for sending the tax revenue to the government. The burden of a tax is primarily determined by the relative elasticities of supply and demand:

• The more inelastic side of the market (either demand or supply) bears a greater share of the tax burden.
• The more elastic side can more easily adjust to the tax, escaping a larger portion of the burden.

Why does the more inelastic side of the market bear a greater tax burden?

Inelasticity means that quantity demanded or supplied is less responsive to price changes. Therefore, the side of the market that is more inelastic has fewer alternatives and less ability to adjust away from the tax. For example, if demand is inelastic, consumers will continue to buy nearly the same amount even as the price rises due to the tax, thus bearing a larger share of the burden.