Chapter 6 Notes: Price Ceilings, Price Floors, and Tax Incidence (Lecture Highlights)

Price ceilings

Chapter context: Chapter 6 applies basic supply and demand (Chapters 4–5) to government interventions that change market rules (price ceilings, price floors, taxes).
Price ceiling: a legal maximum price a seller can charge for a good or service (classic example: rent control).
Key distinction: binding vs nonbinding is an economic concept, not just a legal one. A binding ceiling changes behavior and the outcome; a nonbinding ceiling has no effect on the market outcome.
Setup example (rental market, Kennesaw area):
- Without price controls: equilibrium price $P^* = 800$ per month; equilibrium quantity $Q^* = 300$ units (apartments) – this is the balance where buyers and sellers are happy, no shortage or surplus.
- City council imposes a price ceiling at $P_c = 500$ (maximum rent).
- Demand at the ceiling: $Q^D = 400$ (more students are willing to rent when price falls).
- Supply at the ceiling: $Q^S = 250$ (fewer landlords choose to rent at the lower price).
- Shortage: $Q^D - Q^S = 400 - 250 = 150$ apartments.
Economic interpretation of binding ceiling:
- A binding price ceiling lowers the price below the market-clearing level, creating a shortage because quantity demanded exceeds quantity supplied.
- Shortages tend to be larger in the long run because both demand and supply become more elastic over time, leading to bigger adjustments.
- Long-run projection in the example: supply becomes more elastic and could fall to about $Q^S_{LR} o 150$ , while demand may rise (as more people move to town for cheaper rents).
- Long-run shortage would be $Q^D - Q^S_{LR} = 400 - 150 = 250$ , larger than the short-run shortage of 150.
Market outcomes with a price ceiling:
- Shortages require rationing mechanisms (e.g., long lines, waiting lists).
- Possible discriminatory outcomes by sellers (e.g., preferring non-students or more credit-worthy tenants) due to the shortage.
- Rationale: landlords may prefer tenants who are less likely to cause property damage or higher turnover; students may be at a disadvantage when rents are capped below equilibrium.
Practical takeaway: price ceilings can reduce affordability for intended beneficiaries (e.g., students) and can worsen access even when well-intentioned. Policy design should consider actual market responses and potential unintended consequences.
Nonbinding price ceiling (example):
- Suppose the city sets $P_c = 1000$ , while the market equilibrium $P^* = 800$ .
- Since landlords were already charging below 1000, the ceiling has no economic effect; quantities demanded and supplied remain at the original equilibrium ( $Q = 300, Q^D = Q^S = 300$ ).
- Legally binding, but economically nonbinding; it only matters if the ceiling is set above the equilibrium price.

Price floors

Price floor: a legal minimum price for a good or service (classic example: minimum wage).
Structure of the lesson: start with binding price floors, then nonbinding floors; apply to the labor market with the minimum wage as a central example.
Example setup (unskilled labor):
- Initial equilibrium in the unskilled labor market: $P^* = 4$ (wage per hour); $Q^* = 500$ workers and $Q^* = 500$ jobs.
- City imposes a price floor at $P_f = 5$ (minimum wage).
- Labor supply at the floor: $Q^S = 550$ ; labor demand at the floor: $Q^D = 400$ .
- Result: unemployment (surplus of labor) = $Q^S - Q^D = 550 - 400 = 150$ .
Economic intuition:
- A binding price floor prevents wages from falling to the market-clearing level, reducing quantity demanded and increasing quantity supplied, creating unemployment in the affected sector.
- The minimum wage debate: higher minimums can raise wages for some workers but can price out or eliminate opportunities for others, particularly unskilled or entry-level workers.
- Example discussion: in theory, a higher minimum wage could help low-wage workers but may reduce overall employment for those with the lowest productivity; the real-world effect depends on elasticities and sectoral employment opportunities.
Minimum wage debate notes (illustrative):
- Even though some workers gain higher wages, a proportion of workers (especially those with low productivity) may lose their jobs or fail to enter the labor market at all.
- A common empirical claim: a 10% increase in the minimum wage tends to raise teenage unemployment by about 1–3 percentage points in the short run; larger increases (e.g., to $15/hour) could have larger adverse effects on entry-level opportunities.
Nonbinding price floor example:
- If the floor is set at $P_f = 3$ while the equilibrium wage is $P^* = 4$ , the floor is economically nonbinding and has no effect on the market outcome (no change in employment or wages).
Practical implication: as with price ceilings, the intended policy goal (e.g., helping low-wage workers) may not be realized if market responses offset the intervention.

Taxes and tax incidence (per-unit taxes)

Core idea: taxes are levied to raise revenue, but who actually bears the economic burden (incidence) depends on market responses, not merely on who is legally obligated to pay.
Types of tax incidence:
- Buyer-paid tax (sales tax example): the tax is levied on buyers, but sellers may adjust prices, so the economic burden may fall partly on sellers as well.
- Seller-paid tax (excise tax example, such as gasoline): the tax is levied on sellers, but the price consumers pay can reflect part of the tax through higher prices.
Per-unit taxes: easier to analyze because the tax is a fixed amount per unit sold; the impact on price and quantity can be traced clearly.
Gasoline tax intuition (illustrative): consumers often bear most of the gasoline tax due to inelastic demand (they still need fuel) compared to the more elastic supply side (gas stations can adjust by changing supply mix or prices).
Initial setup (pizza market, no tax):
- Equilibrium: price per pizza $P^* = 10$ ; quantity $Q^* = 500$ .
Tax on buyers (example from lecture):
- Tax amount: $t = 1.50$ per pizza, intended to be paid by buyers.
- Demand shifts downward due to higher out-of-pocket cost to buyers; new equilibrium: $Q = 450$ ; buyers pay a total price of $P_b = 11.00$ (price including tax).
- Seller receipt (price received by sellers) is $Ps = 9.50$ ; the tax wedge is $Pb - P_s = t = 1.50$ .
- Tax incidence outcome in this example: buyers bear most of the tax burden, but some of the tax is absorbed by sellers when sellers lower their prices to keep customers (here, effectively, the split can be described as about $1.00$ borne by buyers and $0.50$ borne by sellers).
- Takeaway: the law may say the tax is on buyers, but the economic incidence reflects the price adjustments and the resulting split depends on elasticities and market responses.
Tax incidence and elasticity (key concept):
- The more inelastic the demand or supply curve, the larger that side’s share of the tax burden will be.
- If demand is relatively inelastic and supply is elastic, buyers tend to bear more of the tax; if demand is elastic and supply is inelastic, sellers tend to bear more of the tax.
Elasticity scenarios illustrated:
- Scenario A (demand more elastic than supply): buyer burden shrinks; seller burden rises relative to Scenario B.
- Scenario B (demand more inelastic): buyer burden increases; seller burden lessened.
- Intuition: elastic sides can adjust quantities more easily; inelastic sides must continue to operate, so they absorb more of the tax.
Relevance to policy and markets:
- The same tax can yield the same macro outcome regardless of whether it’s labeled as a buyer tax or a seller tax, due to how the wedge redistributes prices and quantities.
- The final effect (price paid by buyers, price received by sellers, and quantity transacted) is determined by elasticities, not by whom the law says pays the tax.
Example wrap-up (revisiting the gasoline question):
- Gasoline buyers often bear most of the tax because their demand is relatively inelastic; sellers cannot easily exit the market or substitute away due to high after-tax prices, so some burden shifts to buyers through higher posted prices and reduced consumption.
Tax wedge concept summary:
- Tax wedge: the gap between price paid by buyers and price received by sellers after a tax is imposed.
- Even when the law assigns the tax to one party, the economic incidence can be split differently based on elasticities.
- Formally: if the tax per unit is $t$ , and post-tax buyer price is $Pb$ while seller price is $Ps$ , then $Pb - Ps = t$ , and the distribution of the burden depends on elasticity.
Taxes on sellers (brief preview for next section):
- The next lecture examines taxes legally placed on sellers, and then elasticity is applied to determine incidence.

Practical implications and strategic takeaways

Government interventions (price ceilings, price floors, taxes) interact with existing market incentives and frictions in ways that are often not intuitive without models of supply, demand, and elasticity.
Binding vs nonbinding constraints matter greatly for predicting outcomes.
Elasticity determines burden distribution in tax incidence and the potential for unintended consequences (e.g., shortages, unemployment).
For voters and policymakers: understanding final market outcomes (not just legal intent) is crucial for evaluating whether a policy actually improves welfare.

Quick recap of key concepts

Binding vs nonbinding:
- Price ceiling binding if it lies below the market-clearing price; nonbinding if above.
- Price floor binding if it lies above the market-clearing price; nonbinding if below.
Shortage vs surplus:
- Ceiling below equilibrium → shortage; floor above equilibrium → surplus (unemployment in labor market).
Tax incidence (economic burden):
- The burden depends on relative elasticities of demand and supply, not on legal assignment of the tax.
- Tax wedge: the difference between prices paid by buyers and received by sellers after a tax is imposed.
Elasticity effects:
- More inelastic demand or supply implies greater tax burden on that side; greater elasticity implies greater burden shift to the other side.

Practice reflection prompts (based on lecture content)

If a city imposes a rent ceiling well below the current equilibrium price, what shortages would you expect in the short run and in the long run? How would you expect landlords to ration apartments?
How does a binding minimum wage create unemployment, and why might the long-run effects differ from short-run effects?
In a pizza market with a per-unit tax on buyers, what determines whether buyers or sellers bear more of the tax burden? How would a more elastic demand change the burden distribution?
Why might a price ceiling intended to help students end up making it harder for students to find rental housing? What real-world mechanisms cause this outcome?

Final note on the exam context

The instructor emphasizes that understanding the final market outcomes from supply and demand, and how government interventions interact with elasticity, is essential for evaluating policy proposals.
The session ends with practice multiple-choice questions (MCQs) to reinforce concepts covered in the lecture sections.