Price Controls...
Supply, Demand and
Government Policies
Chapter 6
uAre
usually enacted when
policymakers believe the market
price is unfair to buyers or sellers.
uResult in government-created price
ceilings and floors.
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Price Ceilings & Price Floors
Price Ceiling
uA
legally established maximum price at which
a good can be sold.
Price Floor
uA
legally established minimum price at which a
good can be sold.
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Price Ceilings
Two outcomes are possible when the
government imposes a price ceiling:
u
The price ceiling is not binding if set above
the equilibrium price.
u The price ceiling is binding if set below the
equilibrium price, leading to a shortage.
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A Price Ceiling That Is Not Binding...
Price of
Ice-Cream
Cone
Supply
Price
ceiling
$4
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A Price Ceiling That Is Binding...
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
3
Equilibrium
price
Price
ceiling
2
Shortage
Demand
Demand
0
100
Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Effects of Price Ceilings
A binding price ceiling creates ...
… shortages because QD > QS.
uExample:
Gasoline shortage of the
0
75
125
Quantity
supplied
Quantity
demanded
Quantity of
Ice-Cream
Cones
Lines at the Gas Pump
In 1973 OPEC raised the price of
crude oil in world markets. Because
crude oil is the major input used to
make gasoline, the higher oil prices
reduced the supply of gasoline.
1970s
… nonprice rationing
uExamples:
Long lines, Discrimination
by sellers
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What was responsible for the long
gas lines?
Economists blame government
regulations that limited the price oil
companies could charge for gasoline.
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2
The Price Ceiling on Gasoline Is
Not Binding...
Price of
Gasoline
1. Initially,
the
price ceiling
is not
binding...
The Price Ceiling on Gasoline Is
Binding...
S2
Price of
Gasoline
Supply
2. …but
when supply
falls...
S1
P2
Price
ceiling
$4
Price
ceiling
P1
P1
3. …the price
ceiling becomes
binding...
4. …resulting
in a shortage.
Demand
0
Q1
Quantity of
Gasoline
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Demand
0
Q1
Quantity of
Gasoline
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Rent Control in the Short Run...
Rent Control
uRent
controls are ceilings placed on the
rents that landlords may charge their
tenants.
uThe goal of rent control policy is to help
the poor by making housing more
affordable.
uOne economist called rent control “the
best way to destroy a city, other than
bombing.”
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Rental
Price of
Apartment
Supply
Supply and
demand for
apartments
are relatively
inelastic
Controlled rent
Shortage
Demand
0
Quantity of
Apartments
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3
Rent Control in the Long Run...
Rental
Price of
Apartment
Price Floors
Because the
supply and
demand for
apartments are
more elastic...
Supply
When the government imposes a
price floor, two outcomes are
possible.
u The
…rent control
causes a large
shortage
Controlled rent
Shortage
Demand
0
price floor is not binding if set below
the equilibrium price.
u The price floor is binding if set above the
equilibrium price, leading to a surplus.
Quantity of
Apartments
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A Price Floor That Is Not Binding...
Price of
Ice-Cream
Cone
Supply
A Price Floor That Is Binding...
Price of
Ice-Cream
Cone
Supply
Surplus
Equilibrium
price
$4
$3
Price floor
$3
Price
floor
2
Equilibrium
price
Demand
0
100
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Equilibrium
quantity
Quantity of
Ice-Cream
Cones
Demand
0
80
Quantity
demanded
120
Quantity
supplied
Quantity of
Ice-Cream
Cones
4
Effects of a Price Floor
Effects of a Price Floor
uA
price floor prevents supply and
demand from moving toward the
equilibrium price and quantity.
uWhen the market price hits the
floor, it can fall no further, and the
market price equals the floor price.
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A binding price floor causes . . .
… a surplus because QS >QD.
… nonprice rationing is an alternative
mechanism for rationing the good,
using discrimination criteria.
u Examples: The minimum wage, Agricultural
price supports
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The Minimum Wage
The Minimum Wage
An important example of a
price floor is the minimum
wage. Minimum wage laws
dictate the lowest price
possible for labor that any
employer may pay.
Wage
A Free Labor Market
Labor
supply
Equilibrium
wage
Labor
demand
0
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Equilibrium
employment
Quantity of
Labor
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5
The Minimum Wage
Wage
A Labor Market with a
Minimum Wage
Labor surplus
(unemployment)
Taxes
Labor
supply
Governments levy taxes to
raise revenue for public
projects.
Minimum
wage
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
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Taxes
uTax
incidence refers to who bears
the burden of a tax.
uTaxes result in a change in market
equilibrium.
uBuyers pay more and sellers receive
less, regardless of whom the tax is
levied on.
Impact of a 50¢ Tax Levied on
Buyers...
Price of
Ice-Cream
Cone
Supply, S1
3.00
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).
D1
D2
0
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100
Quantity of
Ice-Cream Cones
6
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Impact of a 50¢ Tax Levied on
Buyers...
Price of
Ice-Cream
Cone
Price
buyers
pay
Price
without
tax
$3.30
3.00
2.80
Price
sellers
receive
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Impact of a 50¢ Tax on Sellers...
Price of
Ice-Cream
Cone
Supply, S1
Price
buyers
pay
Equilibrium without tax
Tax ($0.50)
Price
without
tax
$3.30
3.00
2.80
S2
Equilibrium
with tax
S1
Tax ($0.50)
Equilibrium without tax
Price
sellers
receive
Equilibrium
with tax
D1
Demand, D 1
D2
0
90 100
0
Quantity of
Ice-Cream Cones
A Payroll Tax
Wage
Labor
supply
Wage Tax wedge
without tax
Wage workers
receive
Labor
demand
0
90 100
Quantity of
Ice-Cream Cones
The Incidence of Tax
Wage firms
pay
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A tax on sellers
shifts the
supply curve
upward by the
amount of the
tax ($0.50).
Quantity of
Labor
uIn
what proportions is the burden of
the tax divided?
uHow do the effects of taxes on sellers
compare to those levied on buyers?
The answers to these questions
depend on the elasticity of demand
and the elasticity of supply.
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Elastic Supply, Inelastic Demand...
Price
1. When supply is more
elastic than demand...
Price buyers pay
Supply
Tax
Price without tax
Price sellers receive
3. ...than on
producers.
0
2. ...the
incidence of the
tax falls more
heavily on
consumers...
Inelastic Supply, Elastic Demand...
1. When demand is more
elastic than supply...
Price
Supply
Price buyers pay
Price without tax
3. ...than on consumers.
Tax
Price sellers receive
Demand
Quantity
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0
Demand
2. ...the
incidence of
the tax falls more
heavily on producers...
Quantity
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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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