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

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

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

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

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

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

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

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

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

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?

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

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

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

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

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

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

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

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

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

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

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.

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.

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.

Graphical Review

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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