Chapter 6: Supply, Demand, and Government Policies

Government Policies

• Economists analyze policies seeking to change market outcomes.

• Price controls and taxes alter private market interactions.

Price Controls

• Price Ceiling: Legal max price for goods (e.g., rent control).

  • Binding if set below equilibrium, causing shortages.

  • Example: Price ceiling at $2 creates a shortage of muffins.

• Price Floor: Legal min price for goods (e.g., minimum wage).

  • Binding if set above equilibrium, causing surpluses.

  • Example: Price floor at $4 creates a surplus of muffins.

Effects of Price Controls

• Price ceilings may lead to queuing and secondary markets.

• Price floors can cause surpluses and unintended rationing.

• Rent control can impair housing quality and supply in the long run.

Taxation

• Taxes can be levied on buyers or sellers; the incidence may differ.

• Tax shifts demand or supply curves, adjusting market equilibrium.

• Tax incidence reflects the real burden distributed among market participants.

Elasticity and Tax Incidence

• Tax burden division is determined by the elasticity of demand and supply.

• Less elastic side bears more tax burden.

• Example: Luxury tax burden mainly falls on suppliers due to elastic demand.

Summary

• Price ceilings lead to shortages while price floors lead to surpluses.

• Taxes reduce market size and alter buyer/seller price perceptions.

• Tax burden depends on market elasticity; less elastic side bears more burden.