Market and Government Policies: Price Controls, Taxes, and Subsidies

Introduction to Markets and Government Policies

• Free Market Mechanics回顾:     * Free markets operate through the interaction of demand and supply, which naturally leads to a market equilibrium.     * The price mechanism is the central driver in achieving this equilibrium.

• Rationale for Government Intervention:     * Market equilibria established by free markets are not always considered desirable or equitable by all stakeholders.     * Governments implement specific policies to alter these outcomes, primarily through:         * Price Controls         * Taxes         * Subsidies

Overseas Demand for Australian Residential Property: Context and Modeling

• Credit Suisse Report (March 2014):     * The report identified growing demand for Australian residential property from Chinese constituents, including settlers, temporary residents, and investors.

• Reserve Bank of Australia (RBA) Deposition (June 27, 2014):     * Testimony was provided to the House of Representatives Standing Committee on Economics regarding foreign investment in residential real estate.     * Dr. Christopher Kent (Assistant Governor, Economic Group) stated: ‐‐In terms of the costs, there is some possibility that it is adding somewhat to prices. I do not think that is the main story; I think it is a marginal story.‐‐     * Dr. David Orsmond (Deputy Head, Economic Analysis Department) noted: ‐‐…is all probably adding somewhat to net demand for housing here, and supply is responding accordingly.‐‐

• Interactive Session (PINGO 5718) - Modeling Market Impacts:     * Modeling Housing as Perfectly Competitive: If we model this growth in demand by foreigners, the result would be a shift of the demand curve to the right, which increases house prices.     * Elasticity and Price Dampening: For a growing demand NOT to affect house prices, the supply would need to be perfectly elastic ($e = \infty$).

Price Controls: Definitions and Market Outcomes

• Definition: Price controls are legal restrictions set by governments on the prices that can be charged for goods and services.

• Objectives: To maintain affordability for consumers, ensure minimum income for providers, or achieve a living wage for workers.

• Price Ceiling:     * Definition: A legal maximum on the price at which a good can be sold.     * Outcome 1 (Non-binding): If the ceiling is set above the equilibrium price, it has no effect on the market.     * Outcome 2 (Binding): If the ceiling is set below the equilibrium price, it is considered binding and results in a shortage (Q_{D} > Q_{S}).

• Price Floor:     * Definition: A legal minimum on the price at which a good can be sold.     * Outcome 1 (Non-binding): If the floor is set below the equilibrium price, it has no effect.     * Outcome 2 (Binding): If the floor is set above the equilibrium price, it is considered binding and results in a surplus (Q_{S} > Q_{D}).

Case Study: The Rental Market and Rent Caps

• Motivation: Concerns that rents in major cities have become unaffordable.

• Legislative Action: In July 2022, Greens MP Jenny Leong introduced a private member's bill to the NSW parliament aiming to legislate rent caps tied to inflation.

• Economic Criticism: Economist Saul Eslake argued against such measures, stating:     * They are short-term and ineffective fixes.     * They discourage additional private investment in rental housing.     * They create a privileged class of rent-controlled tenants while potentially harming others.

• Binding Rent Cap Visualization: In a rental market with a binding ceiling (rent cap):     * The price is held below the equilibrium rent ($P_{e}$).     * Quantity supplied ($Q_{S}$) decreases as investment is discouraged.     * Quantity demanded ($Q_{D}$) increases.     * Result: A persistent housing shortage.

Case Study: Minimum Wage and Price Floors

• Function: Minimum-wage laws prevent employers from offering wages below a state-mandated level.

• Australian Context: The Fair Work Commission reviews the National Minimum Wage annually.

• Current Rate: As of 1 July 2025, the National Minimum Wage is set at $\$24.95$ per hour.

• Undesired Effects: A binding floor in the labor market (where the minimum wage is higher than the equilibrium wage) can increase the unemployment level, specifically among unskilled workers, as the quantity of labor supplied exceeds the quantity demanded by employers.

Analysis of Taxes and Market Outcomes

• Purpose: Governments utilize taxes to raise revenue for public infrastructure, projects, and services.

• Tax Incidence: This is the study of who bears the actual burden of a tax, regardless of who is legally required to pay it to the government.

• General Impacts of Taxation:     * Taxes result in a change in market equilibrium.     * In the new equilibrium, the quantity traded is lower than before the tax.     * Taxes discourage market activity.     * Buyers pay more and sellers receive less, meaning both participants share the burden.

Comparative Statics: Tax on Sellers vs. Tax on Buyers

• Tax Levied on Sellers (Example: $\$0.50$ ice-cream tax):     * The tax is perceived by sellers as an additional production cost.     * The supply curve shifts upward by the exact amount of the tax ($\$0.50$).     * Market Result: A new equilibrium is reached at a lower quantity and a higher price.     * Specific Numerical Example (ICE CREAM):         * Initial equilibrium: $\$3.00$ price, $100$ units.         * New market price (paid by buyers): $\$3.30$.         * Effective price received by sellers: $\$3.30 - \$0.50 = \$2.80$.         * Quantity traded: drops to $90$ units.         * Note: The price to buyers increased by less than the full amount of the tax (it rose by $\$0.30$, not $\$0.50$).

• Tax Levied on Buyers (Example: $\$0.50$ ice-cream tax):     * Buyers must pay the market price to the seller PLUS the tax to the government.     * To induce buyers to demand the same quantity, the market price must be $\$0.50$ lower.     * The demand curve shifts downward by the amount of the tax ($\$0.50$).     * Market Result: The market price (received by sellers) falls to $\$2.80$.     * Effective Price Analysis:         * Price sellers receive: $\$2.80$.         * Effective price buyers pay: $\$2.80 + \$0.50 = \$3.30$.         * Initial equilibrium was $\$3.00$.         * Result: Buyers and sellers share the tax burden identically to the tax on sellers.

Determinants of Tax Incidence

• The Elasticity Rule: The burden of a tax falls more heavily on the side of the market that is less elastic (more inelastic).

• Graphical Identification Strategy (The Wedge):     * Shift of curves is not strictly necessary for identification.     * Find two points—one on the Demand curve and one on the Supply curve—where the vertical distance between them equals the tax size.

• Scenario 1: Demand is less elastic than Supply (Steep Demand, Flat Supply):     * The price buyers pay rises significantly.     * The price sellers receive falls only slightly.     * Burden: Falls primarily on buyers (consumers).

• Scenario 2: Supply is less elastic than Demand (Steep Supply, Flat Demand):     * The price buyers pay rises only slightly.     * The price sellers receive falls significantly.     * Burden: Falls primarily on sellers (producers).

Analysis of Subsidies

• Definition: A subsidy is a payment from the government to either consumers or sellers for each unit of a good traded. It is mathematically treated as a "negative tax."

• Market Impacts:     * Quantity traded in equilibrium increases.     * Subsidies encourage market activity but are costly to the government (finance).     * Buyers pay less and sellers receive more.     * Shared Benefits: Regardless of who receives the cash payment, both buyers and sellers share the benefit.

• Specific Numerical Example ($\$1.00$ ice-cream subsidy to sellers):     * Supply curve shifts downward by $\$1.00$.     * New equilibrium results in a lower price for buyers ($\$2.40$) and a higher effective price for sellers ($\$3.40$).     * Compared to initial $\$3.00$ equilibrium: Buyers gain $\$0.60$ and sellers gain $\$0.40$.

• Subsidy Incidence Rule: The less elastic side of the market receives the larger portion of the benefit.

Application: First Home Owner Grant (FHOG) Scheme

• Historical Context: Introduced in 2000 to offset the effects of the Goods and Services Tax (GST) on home ownership.

• Mechanism: The government paid first-time buyers $\$7000$ upon purchasing their first home.

• Economic Analysis of Benefit:     * Market Conditions: Demand from first-home buyers tends to be relatively elastic (price-sensitive). Supply of housing in the short-to-medium term is relatively inelastic (steep supply curve).     * Incidence Result: Because supply is less elastic than demand, the subsidy creates a wedge where the price received by sellers rises substantially, while the price paid by buyers does not fall significantly.     * Conclusion: Sellers gained the vast majority of the $\$7000$ benefit, leading some economists to describe the scheme as a "waste of money" for its intended purpose of assisting buyers.

End of Lecture: Summary of Key Questions

• Question 1: What is the effect of price ceilings and floors on market outcomes?     * Answer: If binding, price ceilings cause shortages; price floors cause surpluses.

• Question 2: What is the effect of taxes and subsidies on market outcomes?     * Answer: They change equilibrium quantity and price. Taxes reduce quantity traded; subsidies increase quantity traded.

• Question 3: Who bears the cost of taxes or benefits from subsidies (Tax Incidence)?     * Answer: It depends on the relative elasticities of buyers and sellers, not on whom the policy is legally imposed. The burden (for taxes) or benefit (for subsidies) falls/goes primarily to the less elastic side of the market.