Government Policies in the Supply/Demand Model

Government Policies in the Supply/Demand Model

Agenda

  • Price controls/regulations

  • Price ceiling (maximum price)

  • Price floor (minimum price)

  • Quantity controls/regulations

  • Taxes

    • Taxes on buyers

    • Taxes on sellers

    • Is there any difference?

Price Ceiling

Definition

  • A price ceiling is defined as a legal maximum price at which a good or service can be sold.

Characteristics

  • Lower prices are allowed under a price ceiling.

  • A price ceiling is only binding if it is set below the market price.

Types of Price Ceilings

  • Non-binding Price Ceiling: When the ceiling is set above the market equilibrium price, it does not affect the market.

  • Binding Price Ceiling: When the ceiling is set below the market equilibrium price, it limits the price and can lead to shortages.

Application

  • Price ceilings are typically applied in politically or socially sensitive markets such as:

    • Gasoline

    • Rental housing

  • In some extreme cases, price ceilings can be set to zero, effectively eliminating markets, such as in the case of organs for transplantation (e.g., kidneys).

Effects of Price Ceilings

  • If the price ceiling is binding:

    • The market price is lower than the equilibrium price.

    • The quantity supplied is lower than the market equilibrium quantity, resulting in supply shortages.

  • Units sold may not go to consumers who value them the most, leading to additional costs:

    • Buyers face search costs to find goods at the controlled price.

Example: US Gasoline Market in the 1970s

  • The Organization of the Petroleum Exporting Countries (OPEC) restricted production and raised crude oil prices. This led to different effects in various countries:

    • Canada: Gas prices increased but no shortages occurred.

    • US: Although gas prices also increased, long lines at gas stations were observed due to the price ceiling in place.

Example: Rent Control

  • Rent controls are prevalent in many regions and can significantly impact housing markets in the long run, as supply and demand become more elastic.

  • This leads to several unintended consequences such as:

    • Lower quality housing

    • Discrimination

    • Occurrence of bribes and additional regulations.

Price Floor

Definition

  • A price floor refers to a legal minimum price at which a good or service can be sold.

Characteristics

  • Higher prices are allowed under a price floor.

  • A price floor is only binding if it is set above the market price.

Types of Price Floors

  • Non-binding Price Floor: When the floor is set below the market equilibrium price and does not affect the market.

  • Binding Price Floor: When the floor is set above the market equilibrium price, leading to surplus.

Examples of Price Floors

  • Minimum Wage: A common example impacting the labor market significantly.

  • Minimum Cigarette Price Laws: Designed to discourage smoking by raising costs.

  • Minimum Alcohol Price in Scotland: Aimed to reduce alcohol consumption and related harms.

Quantity Controls/Regulations

Definition

  • Quantity regulation is defined as a legal minimum or maximum quantity that can be sold.

Mandate

  • A mandate is a requirement to buy or sell a minimum amount.

Examples of Mandate

  • Car insurance mandates that require every driver to have liability insurance.

  • Housing mandates requiring developers to include low-income housing in large developments.

Quota

  • A quota refers to a limit on the maximum quantity of a good that can be bought or sold.

Examples of Quotas

  • Cannabis supply limits on how much can be purchased.

  • City regulations that limit the maximum number of taxis allowed to operate.

  • China's one-child policy (1980-2015) was a relevant historical example of a quota on population control.

Binding Mandate and Quota

  • A binding mandate must be a quantity greater than the equilibrium quantity to have an effect.

  • A binding quota must be a quantity less than the equilibrium quantity.