Econ1101 Chapter 6 Fall 2024 - Spring 2025

Supply and Demand in Economics

• Course: ECON1101: Principles of Microeconomics

• Focus for Fall 2024 – Spring 2025

Price Controls

• Definition: Price controls are regulations set by the government to manage the prices of goods and services.

• Purpose: Policymakers often believe that the market price may be unfair to buyers or sellers, leading to the implementation of price controls.

  • Examples: Price ceilings and price floors are two types of price controls.

• Taxes: Taxes are also a government tool used to raise revenue and influence market outcomes.

Effects of Price Ceilings

• Price Ceiling: This is a maximum price set below the equilibrium price, resulting in a shortage of goods.

  • Binding Constraints: When price ceilings are binding, sellers cannot sell as much as the quantity demanded, leading to rationing.

  • Rationing Mechanisms: Rationing may occur through long lines or discrimination amongst sellers.

  • Example: The situation during the 1973 oil crisis where OPEC raised crude oil prices leading to fuel shortages and long gas lines due to price ceiling regulations.

Price Curves for Ice Cream Cones

• Graphical representation of a market with a price ceiling.

  • Equilibrium Price: Market forces determine the price of ice cream cones but a price ceiling contributes to shortages.

Rent Control

• Rent Control: A price ceiling on rents aimed at making housing affordable to assist the poor.

• Short-term Effects: Leads to small shortages due to inelastic supply and demand.

• Long-term Effects: More significant shortages arise as both supply and demand become more elastic over time.

  • Adverse Consequences: Rent control may be deemed an inefficient method to assist the poor.

Price Floors

• Price Floor: A minimum price set above the equilibrium price that results in a surplus.

  • Binding Constraints: If a price floor is binding, sellers can't sell all they want, causing surplus.

  • Examples: Minimum wage laws established as price floors in the labor market.

Minimum Wage

• Definition: The lowest wage employers can pay workers, aimed to ensure a minimally adequate standard of living.

• Impact: If set above equilibrium, it leads to unemployment among less skilled workers.

  • Effects on Labor Market: Teenage workers are particularly affected as their low-skilled nature makes them more sensitive to wage adjustments.

  • Market Dynamics: When minimum wage increases, employment diminishes due to reduced demand for labor.

Taxation in Economics

• Purpose of Taxes: Taxes are levied to fund public goods such as infrastructure and defense.

• Tax Incidence: Refers to how the burden of tax is distributed between buyers and sellers in a market.

• Effects of Taxes on Sellers: Taxes shift the supply curve leftward, raising equilibrium prices while lowering quantities.

• Effects of Taxes on Buyers: Taxes affect demand by shifting the curve left, resulting in lower equilibrium prices.

Understanding Tax Burden

• Tax Burden Division: Whether taxes are imposed on buyers or sellers, the burden is shared, affecting the prices they receive or pay.

  • Role of Elasticity: The division of tax burden depends on elasticity; the party with less elasticity bears a heavier burden.

• Luxury Tax: A specific instance where a luxury tax was initially imposed but resulted in a heavy burden on suppliers due to the nature of demand elasticity.

• Tax Wedge: Represents the price difference between what buyers pay and sellers receive due to a tax.

Evaluation of Price Controls and Taxes

• Generally, economists oppose heavy regulations like price ceilings and floors due to their capacity to disrupt supply and demand dynamics.

• Taxes play a critical role in the functioning of government but must be balanced to avoid hampering economic activity.