CHAPTER 6: Markets in Action (Pg. 122-124, 126-128, and 130-133)
Housing Markets and Rent Ceilings (Pg. 122-124)
Price (Rent) Ceiling is set below the Market Equilibrium Price → QD > QS → Excess
Demand (Shortage) in the Housing Market.
The Labour Market and the Minimum Wage (Pg. 126-128)
Price (Wage) Floor is set above the Market Equilibrium Price → QD < QS → Excess Supply
(Surplus) in the Labour Market→ Unemployment
Taxes (Pg 130-133)
Tax Incidence (Pg. 130)
Tax Incidence is the division of the tax burden between buyers and sellers
Tax on Sellers (Pg 130)
A unit tax on sellers shifts the supply curve left to S + tax
Tax on Buyers (Pg. 131)
A unit tax on buyers shifts the demand curve left to D - tax
Equivalence of Tax on Buyers and Sellers (Pg. 131)
A tax on Buyers has he same effect as a tax on sellers. In both cases, the equilibrium
quantity decreases, the price paid by buyers rises and the price received by sellers falls.
Tax Division and Elasticity of Demand (Pg. 132)
Perfectly inelastic demand → buyers pay the tax
Perfectly elastic demand → sellers pay the tax
Tax Division and Elasticity of Supply (Pg. 133)
Perfectly inelastic supply → sellers pay the tax
Perfectly elastic supply → buyers pay the tax
Tax Incidence and the Elasticities of Demand and Supply
A tax shifts the supply (or the demand) curve up by the amount of the tax. If demand is more
elastic than supply, consumer price (price consumers pay, inclusive of the tax) rises a little while
producer price (price producers receive, net of the tax) falls a lot. If demand is less elastic than
supply, consumer price rises a lot while producer price falls a little. Thus, consumers bear a
larger share of the tax burden the lower the elasticity of demand relative to the elasticity of
supply.
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Chapter Key Ideas
A. As more people compete for scarce land, housing prices and rents rise. As new technologies
replace low-skilled labour, the demand for low-skilled workers falls. Can governments
control prices and wages and still remain efficient?
B. How do taxes affect market prices and quantities, and who pays the brunt of the tax, the
buyer or the seller?
Outline
I. Housing Markets and Rent Ceilings
A. A Regulated Housing Market
1. A price ceiling is a regulation that makes it illegal to charge a price higher than a
specified level.
2. When a price ceiling is applied to a housing market it is called a rent ceiling.
a. If the rent ceiling is set above the equilibrium rental price for housing, the market
attains equilibrium price and quantity as if there were no ceiling.
b. If the rent ceiling is set below the equilibrium rental price for housing, the quantity of
housing demanded by renters exceeds the quantity of housing supplied by landlords,
resulting in a shortage of rental housing.
3. Because landlords cannot be forced to supply a greater quantity than they wish, the
quantity of housing supplied at the rent ceiling is less than the quantity that would be
supplied in an unregulated market.
4. Because the legal price cannot eliminate the shortage, other mechanisms operate. This
results in increased search activity and encourages black markets to develop.
B. Search Activity
1. The time spent looking for someone with whom to do business is called search activity.
a. When a price is regulated and there is a
shortage, search activity necessarily
increases.
b. Search activity is costly - the opportunity
cost of housing equals its rent (regulated)
plus the opportunity cost of the search
activity (unregulated).
2. Because the quantity of housing is less than
the quantity in an unregulated market, the
opportunity cost of housing exceeds the
unregulated rent - see Figure 6.2.
C. Black Markets
1. A black market is an illegal market in which the price exceeds the legally imposed price
ceiling.
2. A shortage of housing created by a price ceiling results a black market in housing.
3. Illegal arrangements are made between renters and landlords at rents above the rent
ceiling - and generally above what the rent would have been in an unregulated market.
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II. The Labour Market and the Minimum Wage
A. A Minimum Wage
1. A price floor is a regulation that makes it illegal to trade at a price lower than a specified
level.
2. When a price floor is applied to labour markets, it is called a minimum wage.
a. If the minimum wage is set below the equilibrium wage rate, it has no effect. The
market works as if there were no minimum wage.
b. If the minimum wage is set above the equilibrium wage rate, the quantity of labour
supplied by workers exceeds the quantity demanded by employers. There is a surplus
of labour.
3. Because employers cannot be forced to hire a greater quantity of labour than they wish,
the quantity of labour hired at the minimum wage is less than the quantity that would be
hired in an unregulated labour market.
4. Because the legal wage rate cannot eliminate the
surplus, the minimum wage creates unemployment
- Figure 6.5.
III. Taxes
A. Who really pays the taxes? Demand and supply
analysis shows how much of the tax burden the buyer
and the seller share in the payment of a tax.
1. Tax incidence is the division of the burden of a
tax between the buyer and the seller.
a. Buyers respond to the price with the tax,
because that is the price they must pay.
b. Sellers respond to the price without the tax,
because that is the price they receive.
c. The tax is like a wedge driven between the
price paid and price received, altering the incentives facing both buyers and sellers.
2. Tax on Sellers: Figure 6.7 shows how a new
sales tax of $1.50 per carton of cigarettes placed
on the sellers of cigarettes places a wedge
between the price that buyers must pay ($4.00
per pack) and the price sellers actually receive
after the tax ($2.50).
a. The supply curve is shifted leftward. The
vertical distance between the old and new
supply curves is $1.50 at each and every
quantity. This shift arises because the
sellers are only willing to supply the same
amount of cigarettes if they receive the same
price after the tax is paid.
b. The after-tax price that satisfies both the existing buyer’s demand curve and the new
seller’s supply curve is $4.00 per pack.
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c. The new price is higher than the original price ($3.00 per pack), but not by the full
amount of the tax. As a result, that the quantity of cigarettes sold is less than it was
before the tax.
d. A dead weight loss exists where potential gains from trade would have been enjoyed
by society had the tax not been paid. However, both buyers and sellers bear some of
the burden of the tax.
3. Tax on Buyers: Figure 6.8 shows how a new
sales tax of $1.50 per carton of cigarettes placed
on the buyers of cigarettes in places a similar
wedge between the price that buyers must pay
and the price sellers actually receive after the
tax.
a. This time the demand curve is shifted
leftward. The vertical distance between the
old and new supply curves is $1.50 at each
and every quantity because the buyers are
only willing to purchase the same amount of
cigarettes if they can pay the same price
after the tax is paid.
b. The after tax price that satisfies both the existing seller’s supply curve and the new
buyer’s demand curve is at $4.00 per pack, just as before.
c. Again, the new price is higher than the original price ($3.00 per pack), but not by the
full amount of the tax. This result means that the quantity of cigarettes sold is less
than it was before the tax, just like before.
d. A dead weight loss still exists where potential gains from trade would have been
enjoyed by society had the tax not been
paid. Again, both buyers and sellers bear
some of the burden of the tax.
B. Equivalence of Tax on Buyers and Sellers
1. These two scenarios reveal that the effect of
placing a tax on buyers generates the equivalent
result as placing the same tax on buyers - the
new equilibrium price and quantity are
identical.
2. The tax is not necessarily split evenly across
buyer and seller:
a. Comparing the old price that buyers used to
pay ($3.00) with the new price ($4.00),
buyers must bear $1.00 of the tax for each
pack sold.
b. Comparing the old price received by sellers
($3.00) with the new price they used to
receive ($2.50), the sellers bear only $0.50
of the tax for each pack.
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c. In this example, it is the buyers who bear the largest share of the burden imposed by
the tax.
C. Tax Division and Elasticity of Demand
The division of the tax burden between buyer and seller depends on the elasticities of
demand and supply. In extreme cases, the seller or the buyer pays the entire tax.
1. The buyer pays the entire tax if:
a. Demand is perfectly inelastic (the demand curve is vertical). Figure 6.9a shows this
scenario.
b. Supply is perfectly elastic (the supply curve is horizontal). Figure 6.9b shows this
scenario.
2. The seller pays the entire tax if:
a. Demand is perfectly elastic (the demand curve is
horizontal). Figure 6.10a shows this scenario.
b. Supply is perfectly inelastic (the supply curve is
vertical). Figure 6.10b shows this scenario.