Supply, Demand, and Government Policies
Introduction
- Market forces establish equilibrium prices and quantities.
- Economists use theories to develop policies.
Controls on Prices
- Enacted when market prices are perceived as unfair.
- Result in price ceilings and floors.
Price Ceiling
- Legal maximum on the price of a good.
- Effect on Market Outcomes:
- Not binding if above equilibrium price.
- Binding if below, leading to shortages.
Price Floor
- Legal minimum on the price of a good.
- Effect on Market Outcomes:
- Not binding if below equilibrium price.
- Binding if above, leading to surpluses.
Case Study: Gasoline Shortage
- 1970s OPEC oil price increase.
- Price ceiling led to shortages and nonprice rationing.
Case Study: Rent Control
- Ceilings on rents to make housing affordable.
- Short-run benefits but long-run issues.
Taxes
- Governments levy taxes for public projects.
- Effect on Market Outcomes:
- Discourages market activity.
- Quantity sold decreases.
Tax Incidence
- Study of tax burden sharing.
- Burden depends on price elasticities of supply and demand.
Tax on Buyers
- Buyers and sellers share tax burden.
Tax on Sellers
- Buyers and sellers share tax burden, impact depends on elasticity.
Payroll Tax
- Tax incidence depends on elasticities.
Elasticity and Tax Incidence
- Burden falls more heavily on the less elastic side of the market.
Summary
- Price controls: Ceilings and floors.
- Ceilings: Legal maximum.
- Floors: Legal minimum.
- Taxes raise revenue, discourage market activity.
- Tax incidence depends on elasticities.
- Burden on less elastic side of the market.