chp6_business_econ

Chapter 6: Supply, Demand, and Government Policies

Introduction

Focus on understanding key concepts regarding price ceilings, price floors, taxes, and market outcomes.

Price Controls

1. Price Ceiling: A legal maximum price for a good/service.

   • Effect: If established below the equilibrium price, it results in a shortage.

   • Example: Rent control.

2. Price Floor: A legal minimum price for a good/service.

   • Effect: If set above the equilibrium price, it produces a surplus.

   • Example: Minimum wage can lead to unemployment.

Market Examples

In the apartment market, the equilibrium price without any price controls is $800 for 300 apartments. When a price ceiling of $500 is imposed, it leads to a shortage since it is below the equilibrium price. Similarly, in the unskilled labor market, the equilibrium wage without controls stands at $6.00 for 500 workers. A price floor of $7.25 creates a surplus of labor, resulting in unemployment.

Government Regulations

A notable example of energy price controls in the UK was implemented in 2019 when a price cap was introduced to safeguard consumers, greatly affecting a non-competitive market.

Taxes and Their Impact

1. Market Dynamics: Taxes imposed on various goods and services are necessary to fund public expenditures.

   • Effect: This creates a wedge between the price buyers pay and the price sellers receive, regardless of who is initially charged the tax.

2. Tax Examples: In the pizza market, without any tax, the equilibrium price remains at $10.00. However, introducing a $1.50 tax results in the price for buyers increasing to $11.00, while sellers receive only $9.50, leading to a decrease in the equilibrium quantity down to 450 units.

Tax Incidence

The burden of taxation is shared by both buyers and sellers. For example, the buyer ends up paying $1 more, while the seller receives $0.50 less after the tax is imposed.

Summary

Price ceilings tend to create shortages when they are set below the equilibrium price; on the other hand, price floors result in surpluses if established above the equilibrium price. Taxes not only reduce equilibrium quantity but also create a disparity between the prices buyers pay and those received by sellers, with the tax burden determined by market dynamics, independent of how the tax is imposed.