Chapter 6 - Supply, Demand, and Government Policies

6.1 Control on Prices

How Price Ceilings Affect Market Outcomes:

• Price ceiling- a legal maximum on the price at which a good can be sold

• Price floor- a legal minimum on the price at which a good can be sold

• Buyers of any goods always want a lower price while sellers want a higher price

  • The interests of the two groups conflict

• A few examples can be

  • Lines at the Gas pump because of shortage of gasoline due to prices raises
  • Rent control (in the long run and short run)
  • Landlords adjust rent but are still under the ceiling policy that was intended to help the poor by making housing more affordable. Economists claim it's inefficient.
  • More people search for housing over time while there are only a fixed number of apartments to rent.

  

How Price Floors Affect Market Outcomes:

• Similar to price ceilings, price floors impact the sellers

  • They are unable to sell all they want at the market price

• A few examples can be

  • Minimum wage
  • The lowest price for labor that any employer may pay
  • The quality of labor supplied exceeds the quantity demanded and this results in unemployment
  • The minimum wage raises the income of those who have jobs but lowers the incomes of those who cannot find jobs.

  

  

Evaluating Price Controls:

• It is often aimed to assist the poor
• But it can also hurt those who are trying to assist, sellers like landlords don’t benefit from it

6.2: Taxes

How Taxes on Sellers Affect Market Outcomes:

• Tax incidence- the manner in which the burden of a tax is shared among participants in a market

• Because the tax doesn’t affect buyers, the quantity of ice cream demanded at any given price is the same. So the demand curve does not change

  • But sellers make less profit from their business so the supply curve changes.

• Soon, market prices rise and buyers pay more than their previous price, making the buyers worse off and it converts tax to the government

  

How Taxes on Buyers Affect Market Outcomes:

• The taxes impact the demand-supply

• Not only do they have to pay tax to the government, they also have to pay taxes to the seller

• Taxes levied on sellers and taxes levied on buyers are equivalent

  • The difference is who sends the money to the government

  

Can Congress Distribute the Burden of a Payroll Tax?:

• Half of the tax is paid by firms, and half is deducted from workers’ paychecks
• No, congress cannot distribute the burden of a payroll tax

Elasticity and Tax Incidence:

• A tax burden falls more heavily on the side of the market that is less elastic

• Elasticity measures the willingness of buyers or sellers to leave the market when conditions become unfavorable

• The supply of labor is much less elastic than the demand

  • Workers rather than firms bear most of the burn of the payroll tax
  • That means that the distribution isn’t exactly 50-50 like lawmakers had intended

  

Who Pays the Luxury Tax:

• Taxing luxuries seemed a logical way of taxing the rich since the rich are the ones who could afford extravagances such as yachts, private airplanes, jewelry, expensive cars, etc.
  • The goal of the tax was to raise revenue from those who could most easily afford to pay
• But a millionaire can use the same money to possibly buy another house or take a trip instead.
  • This results in the supply of yachts being relatively inelastic
  • This means that with elastic demands and inelastic supplies, the burden of the tax falls largely on the suppliers rather than the rich

\