1. Repealing the Laws of Supply and Demand: Price Controls
Price Ceiling
A legally established maximum price at which a good can be sold.
Price Floor
A legally established minimum price at which a good can be sold. 4 4

2. A Price Ceiling That Is Not Binding...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Not Binding...
Price of
Ice-Cream
Cone
Supply $4
Price
ceiling 3
Equilibrium
price
Demand
100
Quantity of
Ice-Cream
Cones
Equilibrium
quantity 6 7

3. A Price Ceiling That Is Binding...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Binding...
Price of
Ice-Cream
Cone
Supply
Equilibrium
price $3 2
Price
ceiling 75
Quantity
supplied
125
Quantity
demanded
Shortage
Demand
Quantity of
Ice-Cream
Cones 7 10

4. The 1970s Energy Crisis: The Price Ceiling on Gasoline
Price of
Gasoline
2. …but when supply falls... S1 P2
Price
ceiling
4. …resulting in a shortage.
3. …the price ceiling becomes binding... P1
Demand
Quantity of
Gasoline Q1 6 7

5. Rent Control in the Short Run...
Rental Price of
Apartment
Supply and demand for apartments are relatively inelastic
Supply
Controlled rent
Shortage
Demand
Quantity of
Apartments 7 10

6. Rent Control in the Long Run...
Because the supply and demand for apartments are more elastic...
Rental Price of
Apartment
Supply
…rent control causes a large shortage
Controlled rent
Shortage
Demand
Quantity of
Apartments 7 10

7. The Minimum Wage: An important example of a price floor …

8. A Free Labor Market Labor supply Labor demand Wage Equilibrium wage
employment
Labor
demand
Quantity of
Labor

9. A Labor Market with a Minimum Wage
The Minimum Wage
A Labor Market with a Minimum Wage
Wage
Labor
supply
Labor surplus
(unemployment)
Minimum
wage
Quantity
demanded
Quantity
supplied
Labor
demand
Quantity of
Labor

10. What are the equilibrium price and quantity of Frisbees?
Frisbee manufacturers persuade the government that Frisbee production improves scientists’ understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees are sold?
Irate college students march on Washington and demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former price floor. What is the new market price? How many Frisbees are sold?

11. Governments levy taxes to raise revenue for public needs.20 29

12. What are some potential impacts of taxes?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Buyers and sellers share the tax burden. 22 30

13. Impact of a 50¢ Tax Levied on Buyers...
Copyright © 2001 by Harcourt, Inc. All rights reserved
Impact of a 50¢ Tax Levied on Buyers...
Price of
Ice-Cream
Cone
Supply, S1 D2
3.00
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50). D1
100
Quantity of
Ice-Cream Cones 23 33

14. Impact of a 50¢ Tax Levied on Buyers...
Copyright © 2001 by Harcourt, Inc. All rights reserved
Impact of a 50¢ Tax Levied on Buyers...
Price of
Ice-Cream
Cone
Supply, S1
$3.30
Price
buyers
pay
Equilibrium without tax
Tax ($0.50)
Price
without
tax
3.00
2.80
Price
sellers
receive
Equilibrium
with tax D1 D2 90
100
Quantity of
Ice-Cream Cones 23 38

15. What was the impact of tax?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Tax puts a wedge between the price buyers pay and the price sellers receive.
Buyers and sellers share the tax burden. 22 30

16. Impact of a 50¢ Tax on Sellers...
Copyright © 2001 by Harcourt, Inc. All rights reserved
Impact of a 50¢ Tax on Sellers...
Price of
Ice-Cream
Cone
A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50).
$3.30
Price buyers pay S2
Equilibrium
with tax S1 90
Tax ($0.50)
3.00
Price without tax
Equilibrium without tax
2.80
Price sellers receive
Demand, D1
100
Quantity of
Ice-Cream Cones

17. What was the impact of tax?
Taxes discourage market activity.
When a good is taxed, the quantity sold is smaller.
Tax puts a wedge between the price buyers pay and the price sellers receive.
Buyers and sellers share the tax burden. 22 30

18. Elastic Supply, Inelastic Demand...
Price
1. When supply is more
elastic than demand...
Price buyers pay
Tax
2. ...the
incidence of the
tax falls more
heavily on
consumers...
Supply
Price without tax
3. ...than on
producers.
Price sellers receive
Demand
Quantity 32 44

19. Inelastic Supply, Elastic Demand...
1. When demand is more
elastic than supply...
Price
Supply
Price buyers pay
Tax
3. ...than on consumers.
Price without tax
2. ...the
incidence of
the tax falls more
heavily on producers...
Demand
Price sellers receive
Quantity 32 51

20. 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.
If you can’t easily adjust, you’re stuck paying most of the tax. 30 41

21. 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.

22. Summary 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.

23. Summary
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.

24. Graphical Review

25. A Price Ceiling That Is Not Binding...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Not Binding... $4 3
Quantity of
Ice-Cream
Cones
Price of
Cone
Demand
Supply
Price
ceiling
Equilibrium
price
100
quantity 6 7

26. A Price Ceiling That Is Binding...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Ceiling That Is Binding... $3
Quantity of
Ice-Cream
Cones
Price of
Cone 2
Demand
Supply
Equilibrium
price
Price
ceiling
Shortage
125
Quantity
demanded 75
supplied 7 10

27. The Price Ceiling on Gasoline Is Not Binding...$4 P1
Quantity of
Gasoline
Price of Q1
Demand
Supply
Price
ceiling
1. Initially, the
price ceiling is not binding... 6 7

28. The Price Ceiling on Gasoline Is Binding...
Quantity of
Gasoline
Price of Q1
Demand S1
Price
ceiling S2
2. …but when supply falls... P2
3. …the price ceiling becomes binding...
4. …resulting in a shortage. 6 7

29. Rent Control in the Short Run...
Quantity of
Apartments
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Supply and demand for apartments are relatively inelastic 7 10

30. Rent Control in the Long Run...
Quantity of
Apartments
Rental Price of
Apartment
Demand
Supply
Controlled rent
Shortage
Because the supply and demand for apartments are more elastic...
…rent control causes a large shortage 7 10

31. A Price Floor That Is Not Binding...$3
Quantity of
Ice-Cream
Cones
Price of
Cone
100
Equilibrium
quantity
price
Demand
Supply
Price
floor 2 8 17

32. A Price Floor That Is Binding...
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
A Price Floor That Is Binding... $3
Quantity of
Ice-Cream
Cones
Price of
Cone
Equilibrium
price
Demand
Supply
Price floor $4
120
Quantity
supplied 80
demanded
Surplus 8 17

33. The Minimum Wage A Free Labor Market supply demand Wage Equilibrium
Quantity of
Labor
Wage
Equilibrium
wage
demand
supply
A Free Labor Market
employment

34. A Labor Market with a Minimum Wage
The Minimum Wage
Minimum
wage
Quantity of
Labor
Wage
demand
supply
Quantity
supplied
demanded
Labor surplus
(unemployment)
A Labor Market with a Minimum Wage

35. Impact of a 50¢ Tax Levied on Buyers...
3.00
Quantity of
Ice-Cream Cones
Price of
Ice-Cream
Cone
100 D1
Supply, S1
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50). D2 23 33

36. Impact of a 50¢ Tax Levied on Buyers...
3.00
Quantity of
Ice-Cream Cones
Price of
Ice-Cream
Cone
100 90
$3.30
Price
buyers
pay D1 D2
Equilibrium
with tax
Supply, S1
Equilibrium without tax
2.80
sellers
receive
without
tax
Tax ($0.50) 23 38

37. Impact of a 50¢ Tax on Sellers...
3.00
Quantity of
Ice-Cream Cones
Price of
Ice-Cream
Cone
100 90 S1 S2
Demand, D1
Price without tax
2.80
Price sellers receive
$3.30
Price buyers pay
Equilibrium without tax
A tax on sellers shifts the supply curve upward by the amount of the tax ($0.50).
Tax ($0.50)
Equilibrium
with tax

38. A Payroll Tax supply demand Wage Wage firms pay Tax wedge
Quantity of
Labor
Wage
Wage without tax
demand
supply
Tax wedge
Wage firms pay
Wage workers receive

39. Elastic Supply, Inelastic Demand...
Quantity
Price
Demand
Supply
Tax
1. When supply is more
elastic than demand...
2. ...the
incidence of the
tax falls more
heavily on
consumers...
3. ...than on
producers.
Price without tax
Price buyers pay
Price sellers receive 32 44

40. Inelastic Supply, Elastic Demand...
Quantity
Price
Demand
Supply
Price without tax
Tax
1. When demand is more
elastic than supply...
2. ...the
incidence of
the tax falls more
heavily on producers...
3. ...than on consumers.
Price buyers pay
Price sellers receive 32 51