Chapter 6: Government Intervention

two types of price controls

Price ceiling

• the government sets the maximum pric ethat can legally be charged or paid

  • in the US price ceilings are now used for rents. in the oast gasoline was subject to price ceiling

Price floor

• the government sets the minimum pric ethat can be legally be charged or paid

  • in the US, price floors are now used for many agricultural products. the minimum wage is a price floor

Price ceiling

effects of a price ceiling

• you can charge any price until that line, all prices above are illegal

• if its above the equilibrium price, t makes the equilibrium price illegally

  • this causes something to change

    • a shortage

    • increased search activity

    • an illicit market

• this causes:

  • Black markets/ illicit market

    • markets in which an otehrwhise legal good trades at an illegale price

  • search

    • efforts to find something from whom to buy or sell from

• set bellow equilibrium price = change

• shortage

welfare effects of a price ceiling

• gov want to lower price and has to be set bellow the equilibrium price

• under producing creates deadweight loss

Price floor

• imcant above the equilibrium price

• surplus

effects of a minimum wage

1. Illegal hiring

   1. some workers and firms will agree to lower wages lower than the minimum wage

2. search

   1. as workers search for jobs, they are unemployed

• makes equilibrium wage illegal so something has to change

welfare effects of a minimum wage

• marginal social benefit marginal social cost

• Gain:

  • workers who keep their jobs and pay hier wages

• loss:

  • all employers

  • workers who lose their jobs

labor union

taxes on buyers

• perfectly inelastic demand- buyers pay

• perfectly elastic demand- sellers pay

taxes on sellers

• difference between supply curves is the tax (aka $1 in this example)

• tax created dead weight loss

tax incidence

• who actually pay the tax

  • the tax incidence depends on the price elasticity of demand and the price elasticity of supply

• for a given price elasticity of supply

  • the larger the price elasticity of demand, the less of the tax the demanders pay

  • the smaller the price elasticity of the demand, the more of the tax the demanders pay

• for a given price elasticity of demand

  • the lager the price elasticity of supply, the less of the taxt the suppliers pay

  • the smaller the price elasticity of supply, the more of the tax the suppliers pay

• who ever has the lager elasticity pays less and vise versa

• Perfect inelastic supply = sellers pay

• perfect elastic supply= buyers pay

taxes and fairness

the benefits principle

• people should pay taxes equal to the benefits they receive fro the services provided by the government

• those who benefit most pay most

ability to pay principle

• people should pay taxes according to how easily they can bear the burden of the tax

production quotas and subsides

production quotas

• an upper limit to the quantity of a good that may be produced in a specified period

• effects of the PW depends on where its set bellow or above the equilibrium quantity.

  • if above= nothing changes

  • if bello =

    • a decrease in supply

    • a rise in price

    • a decrease in marginal cost

    • inefficient underproduction

    • an incentive to cheat and over produce

Subsides

• a payment made by the giv to a producer

• effects are similar to tax but the opposite directions

  • increase in supply

  • a fall in price and increase in quantity produced

  • an increase in marginal cost

  • payments by govt to farmers

  • inefficient overproduction

market of illegal goods

• Definition: Markets for many goods and services are regulated; some goods are illegal to buy and sell (e.g., drugs like cocaine, ecstasy, heroin, methamphetamine, and in some states, marijuana).

• Trade Dynamics: Despite their illegality, the trade in these drugs is a multibillion-dollar business. The economic models explaining trade in legal goods can also be applied to illegal goods.

• Key Concepts:

  • Prices and Quantities: Analyze what market prices and quantities would look like if these goods were legal.

  • Prohibition Impact: Understanding how prohibition affects supply and demand.

  • Taxation's Role: Exploring how taxation can limit consumption of illegal goods.

• A Free Market for a Drug:

  • Demand Curve (D): Lower drug prices lead to higher quantity demanded.

  • Supply Curve (S): Lower drug prices result in lower quantity supplied.

  • Equilibrium Price/Quantity: If drugs were legal, equilibrium would be at price Pc and quantity Qc.

• Cost of Legality:

  • Cost of Breaking the Law: The illegal status raises the cost of trading, influenced by penalties and law enforcement.

• Penalties on Sellers:

  • Drug dealers in the U.S. face severe penalties, including long jail terms and hefty fines.

  • Result: Decreased supply as the supply curve shifts left (S + CBL).

• Penalties on Buyers:

  • Possessing illegal drugs can lead to serious penalties, impacting maximum buyer prices and demand.

  • Result: Demand decreases as the demand curve shifts left (D-CBL).

• Penalties on Both Sellers and Buyers:

  • If penalties apply to both, supply and demand shift left, affecting market equilibrium.

  • Price remains at Pc; however, the quantity traded decreases to Qp.

• Effects of Enforcement:

  • Higher penalties increase the decrease in demand and/or supply. Depending on who faces heavier penalties, either the price rises or falls compared to the competitive market.

• Challenges in Enforcement:

  • High costs and resource limitations hinder effective law enforcement.

  • Result: It’s rare to decrease demand/supply to zero.

• Debate on Legalization:

  • There are calls for legalizing and taxing drugs as a potential policy solution to the failures of prohibition policies