Chapter 4: Government intervention in markets Price controls Price ceiling Price floor Quantity controls— quota Inefficiency Excise tax Excess burden Tax incidence Deadweight loss

The Market for Apartments in the Absence of Government Controls Without government intervention, the market for apartments reaches equilibrium at point E with a market rent of $1,000 per month and 2 million apartments rented.

The Effects of a Price Ceiling

Price ceilings cause inefficiency! Inefficiency = missed opportunities: Some people could be made better off without making other people worse off. Price ceilings often lead to inefficiency in the forms of: Inefficient allocation to consumers If prices were allowed to go higher, some people would give up their apartments, allowing people who were willing to pay more to rent

Wasted resources Because price ceilings cause a shortage, potential buyers have to wait in lines, or spend more time to make a transaction. Inefficiently low quality Why would a landlord fix up an apartment when rents cannot be increased? They also produce black markets, or illegal transactions. Example: Trout and salmon from Lake Michigan.

The Market for Butter with no Government Controls Without government intervention, the market for butter reaches equilibrium at a price of $1 per pound and with 10 million pounds of butter bought and sold.

The Effects of a Price Floor

Price Floors Cause Inefficiency! The most familiar price floor is the minimum wage. Price floors are also commonly imposed on agricultural goods. Price floors often lead to inefficiency in the forms of: Inefficient allocation of sales among sellers Wasted resources What happens to surplus butter? Inefficiently high quality

So why are there price floors? Price floors benefit some influential sellers. Government officials believe their actions will correct the market. Political concerns are more important! Campaign contributions - Lobbyists

Controlling Quantities A quantity control, or quota, is an upper limit on the quantity of some good that can be bought or sold. The total amount of the good that can be legally transacted is the quota limit.

The Market for Taxi Rides in the Absence of Government Controls Without government intervention, the market reaches equilibrium with 10 million rides taken per year at a fare of $5 per ride.

Effect of a Quota on the Market for Taxi Rides

A quota drives a wedge between the demand price (the price paid by buyers) and the supply price (the price received by sellers) of a good. The difference between the demand and supply price at the quota limit is the quota rent, the earnings that accrue to the license-holder. In this example, the license itself is worth $2.00 per ride to the license holder.

Excise Taxes Excise taxes are taxes on the purchase or sale of a good. They have effects similar to quotas: raise the price paid by buyers and reduce the price received by sellers, and drive a wedge between the two. Examples: Excise tax levied on sales of taxi rides and excise tax levied on purchases of taxi rides

Effect of an Excise Tax Levied on the Sales of Taxi Rides – Taxi owner pays tax

Effect of an Excise Tax Levied on the Purchases of Taxi Rides – tax paid by taxi customers

The incidence of a tax is a measure of who really pays it. Who really bears the tax burden (higher prices to consumers and lower prices to sellers) does not depend on who officially pays the tax. Depending on the shapes of supply and demand curves, the incidence of an excise tax may be divided differently. The wedge between the demand price and supply price becomes the government’s tax revenue. It might be a good idea to mention “elasticity” and how tax incidence depends on elasticity of demand and elasticity of supply. The text only mentions “the shape of curves” but doesn’t provide an explanation involving elasticities, since elasticity is not covered yet. At this point, telling the students that the next chapter (chapter 5) would shad some more light on the tax incidence and mentioning the “coming attractions” might be useful.

The Revenue from an Excise Tax Area of triangle ABE = deadweight loss Area of the shaded rectangle: $2 per ride × 8 million rides = $16 million.

Excise taxes also cause inefficiency: excess burden or deadweight loss. This excess burden, or deadweight loss, means that the true cost is always larger than the amount paid in taxes. Excise taxes prevent some mutually beneficial transactions. They also encourage illegal activity in attempts to avoid the tax.

The End of Chapter 4