© 2007 Thomson South-Western. CONTROLS ON PRICES Controls on Prices are enacted when …...


CONTROLS ON PRICESControls on Prices are enacted when …

– policymakers believe the market price is unfair to buyers or sellers


CONTROLS ON PRICES• Price Ceiling

– A legal maximum on the price at which a good can be sold.


A Price Ceiling on Tacos???

Price per Taco Q of Tacos Demanded

Q of Tacos Supplied

1 9 1

2 8 2

3 7 3

4 6 4

5 5 5

6 4 6

7 3 7

8 2 8

9 1 9

10 0 10


A Market with a Price Ceiling

Quantity ofTacos

0

Price ofTaco

Demand

Supply

3 PriceceilingShortage

Quantitysupplied

Quantitydemanded

Equilibriumprice

$5

3 5 7Equilibrium Quantity


Effects of a Price Ceiling

• Shortages • QD > QS

• Inefficient allocation to consumers• Missed opportunities

• Wasted resourcesOpportunity cost of looking for a taco

• Inefficiently low quality• Taco suppliers ‘cut corners’ on quality

• Black Market • Goods bought and sold illegally


CASE STUDY: Lines at the Gas Pump

• Economists blame government regulations that limited the price oil companies could charge for gasoline.

• In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline.

• What was responsible for the long gas lines?


The Market for Gasoline with a Price Ceiling(b) The Price Ceiling on Gasoline Is Binding

Quantity ofGasoline

0

Price ofGasoline

Demand

S1

S2

Price ceiling

QS

P2

QD

P1

Q1

Shortage


CONTROLS ON PRICES

• Price Floor– A legal minimum on the price at which a good

can be sold.


A Price Ceiling on Tacos???

Price per Taco Q of Tacos Demanded

Q of Tacos Supplied

1 9 1

2 8 2

3 7 3

4 6 4

5 5 5

6 4 6

7 3 7

8 2 8

9 1 9

10 0 10


A Market with a Price Ceiling

Quantity ofTacos

0

Price ofTaco

Demand

Supply

7 Pricefloor

Surplus

Quantitydemanded

Quantitysupplied

Equilibriumprice

$5

3 5 7Equilibrium Quantity


Effects of a Price Floor• Surplus

– QS > QD

• Inefficient allocation of sales among sellers– Missed opportunities

• Wasted resources

Government may have to buy surplus• Inefficiently high quality

buyers prefer a lower quality good at a lower price• Inefficiently low quantity

– Fewer people buying tacos so a loss to society• Black Market

– Bribes of seller or government officials


CASE STUDY: The Minimum Wage

• An important example of a price floor is the minimum wage.

• Minimum wage laws dictate the lowest price possible for labor that any employer may pay.


How the Minimum Wage Affects the Labor Market

Quantity ofLabor

Wage

0

Labordemand

LaborSupply

Equilibriumemployment

Equilibriumwage


How the Minimum Wage Affects the Labor Market

Quantity ofLabor

Wage

0

LaborSupplyLabor surplus

(unemployment)

Labordemand

Minimumwage

Quantitydemanded

Quantitysupplied


Quantity Controls - Quotas

A quota is …

• an upper limit on the quantity of some

good that can be bought or sold.

• usually controlled by a license


Example: Ocean Caught Salmon Market

What controls how many each salmon boat may catch?

Licenses are allocated.

Total quota limit reached

=

ocean caught salmon season is OVER!!!


Quota Graph

Quota S

Pd

Pe

Ps

D

Qe Q


Costs of Quantity Controls

• Inefficiency – missed opportunities

• Incentives for illegal activities - poaching


TAXES• Governments levy taxes to raise revenue for

public projects.


How Taxes on Buyers (and Sellers) Affect Market Outcomes

• Taxes discourage market activity.

• When a good is taxed, the quantity sold is smaller.

• Buyers and sellers share the tax burden.


How Taxes on Buyers Affect Market Outcomes

• Elasticity and tax incidence • Tax incidence is the manner in which the burden of

a tax is shared among participants in a market.


How Taxes on Buyers Affect Market Outcomes

• Elasticity and Tax Incidence• Tax incidence is the study of who bears the burden

of a tax. • Taxes result in a change in market equilibrium.• Buyers pay more and sellers receive less, regardless

of whom the tax is levied on.


Figure 6 A Tax on Buyers

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

Pricewithout

tax

Pricesellersreceive

Equilibrium without taxTax ($0.50)

Pricebuyers

pay

D1

D2

Supply, S1

A tax on buyersshifts the demandcurve downwardby the size ofthe tax ($0.50).

$3.30

90

Equilibriumwith tax

2.803.00

100


Figure 7 A Tax on Sellers

2.80

Quantity ofIce-Cream Cones

0

Price ofIce-Cream

Cone

Pricewithout

tax

Pricesellersreceive

Equilibriumwith tax

Equilibrium without tax

Tax ($0.50)

Pricebuyers

payS1

S2

Demand, D1

A tax on sellersshifts the supplycurve upwardby the amount ofthe tax ($0.50).

3.00

100

$3.30

90


Elasticity and Tax Incidence

• What was the impact of tax? • Taxes discourage market

activity.• When a good is taxed, the

quantity sold is smaller. • Buyers and sellers share

the tax burden.


Figure 8 A Payroll Tax

Quantityof Labor

0

Wage

Labor demand

Labor supply

Tax wedge

Wage workersreceive

Wage firms pay

Wage without tax



• In what proportions is the burden of the tax divided?

• How do the effects of taxes on sellers compare to those levied on buyers?

• The answers to these questions depend on the elasticity of demand and the elasticity of supply.


Figure 9 How the Burden of a Tax Is Divided

Quantity0

Price

Demand

Supply

Tax

Price sellersreceive

Price buyers pay

(a) Elastic Supply, Inelastic Demand

2. . . . theincidence of thetax falls moreheavily onconsumers . . .

1. When supply is more elasticthan demand . . .

Price without tax

3. . . . than on producers.


Figure 9 How the Burden of a Tax Is Divided

Quantity0

Price

Demand

Supply

Tax

Price sellersreceive

Price buyers pay

(b) Inelastic Supply, Elastic Demand

3. . . . than onconsumers.

1. When demand is more elasticthan supply . . .

Price without tax

2. . . . theincidence of the tax falls more heavily on producers . . .



So, how is the burden of the tax divided?

The burden of a tax falls more heavily on the side of the market that is less elastic.

© 2007 Thomson South-Western. CONTROLS ON PRICES Controls on Prices are enacted when …...

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