Controls on prices
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CONTROLS ON PRICES. Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Price Ceiling - legal maximum on the price at which a good can be sold. Price Floor - legal minimum on the price at which a good can be sold.. Price Ceiling.

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CONTROLS ON PRICES

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Controls on prices

CONTROLS ON PRICES

  • Are usually enacted when policymakers believe the market price is unfair to buyers or sellers.

  • Price Ceiling - legal maximum on the price at which a good can be sold.

  • Price Floor - legal minimum on the price at which a good can be sold.


Price ceiling

Price Ceiling

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

S

$/Q

Shortage = Q2 – Q1

P*

Max. P

D

Q/t

Q2

Q1


How price ceilings affect market outcomes

How Price Ceilings Affect Market Outcomes

A binding price ceiling creates

  • shortages because QD > QS.

  • nonprice rationing

    • Discrimination

    • Wasted resources as buyers search for goods

    • Inefficient distribution of goods among buyers

    • Illegal market.


How price floors affect market outcomes

How Price Floors Affect Market Outcomes

- legal minimum on the price at which a good can be sold.

price

S

min. p

Surplus = Q2 – Q1

P*

D

Q/t

Q2

Q1


How price floors affect market outcomes1

How Price Floors Affect Market Outcomes

A binding price floor causes . . .

  • a surplus because QS > QD.

    Examples: The minimum wage, agricultural price supports.

  • nonprice rationing- floor enhances buyers’ power-

    • is an alternative mechanism for rationing the good, using discrimination criteria.


Who pays the tax

Who Pays the Tax?

10 m. packs of cigarettes sell for $2/pk. A tax of $1 per pack is levied. Results: consumption falls by 1m. packs and the price rises to ___?

Pd = price that buyers pay (includes the tax).

Ps = price that sellers keep (excludes the tax).

Without a tax, Pd=Ps. With a tax, Pd - tax = Ps.

Pd

Q

Without tax

2.00

10

With tax = $1/Q

2.80

9


Who pays the tax1

Who Pays the Tax?

Pd = price buyers pay.

Ps = price sellers keep.

Without a tax, Pd=Ps.

With a tax, Pd - tax = Ps.

Pd

Q

Without tax

2.00

10

With tax = $1/Q

2.80

9

$/pk.

2.80

S

Buyers pay $0.80

2.00

1.80

Sellers pay the other $0.20.

D

m. pk. per mth.

9

10


Who pays the tax2

Who Pays the Tax?

Tax of $4/hr on workers.

S + $4

wage

S

$14

11

10

D

7

Pd – tax = Ps

m. hours

35

40


Controls on prices

Who Pays the Tax?

Tax of $4/hr on employers.

wage

S

11

10

7

D

6

Pd – tax = Ps

D -$4

m. hours

35

40


Who sends the tax to the government does not matter

Who sends the tax to the government does not matter!

S+$4

wage

S

14

Pd – tax = Ps

11

10

D

7

6

D-$4

m. hours

40

35


Who pays the tax3

Who Pays the tax?

Depends on elasticities of S and D, not on who sends the check to the government.

Buyers pay most of the tax here.

P

S

P

S

D

Sellers pay most here.

D

Q

Q


Summary

Summary

  • Price controls include price ceilings and price floors.

  • A price ceiling is a legal maximum on the price of a good or service. An example is rent control.

  • A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage.

  • Taxes are used to raise revenue for public purposes.

  • When the government levies a tax on a good, the equilibrium quantity of the good falls.

  • A tax on a good places a wedge between the price paid by buyers and the price received by sellers.

  • The incidence of a tax refers to who bears the burden of a tax.

  • The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.

  • The incidence of the tax depends on the price elasticities of supply and demand.

  • The burden tends to fall on the side of the market that is less elastic.


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