Supply, Demand, and Government
Policies
• In a competitive, unregulated market system,
market forces establish equilibrium prices and
facilitate mutually beneficial voluntary exchange.
• While equilibrium conditions may be efficient, it
may be true that not everyone is satisfied.
• One of the roles of economists is to use their
theories to assist in the development of policies.
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CONTROLS ON PRICES
• Price controls are usually enacted when policymakers
believe the market price is unfair to buyers or sellers.
• Price Ceiling: Rent Control (apartment rental)
• A legal maximum on the price at which a good can be
bought and sold (designed to help buyers).
• Price Floor: Minimum Wage (labor)
• A legal minimum on the price at which a good can be
bought and sold (designed to help sellers).
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How Taxes on Buyers (and Sellers)
Affect Market Outcomes
• Governments levy taxes to raise revenue for
public projects.
• Gasoline, Cigarettes, Alcohol, Food, Labor
• Governments also levy taxes to discourage certain
activities.
• Gasoline, Cigarettes, Alcohol, Food, Labor
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Elasticity and Tax Incidence
• Tax incidence is the study of who bears the burden of a
tax in a market (split burden).
• Placing a tax in a market changes the equilibrium
price(s) and quantity.
• Compared to the competitive market equilibrium
outcome:
• Buyers pay a higher price, sellers receive a lower price.
• Fewer units are bought and sold.
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Elasticity and Tax Incidence
• How do taxes affect sellers and buyers?
• How is the burden split?
• How much revenue is raised?
• The answers to these questions depend on the
price elasticities of demand and supply.
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ELASTICITY AND TAX INCIDENCE
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.
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Summary
• Price controls are government regulated prices.
• A price ceiling is a regulated maximum price of a
good or service such as rent control.
• A price floor is a regulated minimum price of a
good or a service such as a minimum wage.
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Summary
• Taxes are used to raise revenue for public projects
and also to discourage certain activities.
• When the government levies a tax in a market, the
equilibrium quantity of the good falls.
• A tax in a market creates a wedge between the
buyer’s price and the seller’s price. Sellers receive
a lower price and buyers pay a higher price.
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Summary
• The incidence of a tax refers to who bears the
burden of a tax.
• The incidence of a tax depends on the price
elasticities of supply and demand.
• The tax burden tends to fall more heavily on the
inelastic side of the market.
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