Price Ceilings, Price Floors, and
Excise Taxes
Governments & markets
slide 1
Price ceiling:
A price above which it is illegal to charge.
Binding price ceiling:
A price ceiling set below the equilibrium
price.
Governments & markets
slide 2
A binding price ceiling
p
S
Price can't rise above
this level, so there's
always excess demand.
p(max)
D
q
Governments & markets
slide 3
A binding price floor
p
S
p(min)
Price can't fall below this
level so there's always a
surplus.
D
q
Governments & markets
slide 4
Binding price ceilings lead to shortages
(excess demand).
Binding price floors lead to surpluses (excess
supply).
Governments & markets
slide 5
Additional examples:
Rent control
Minimum wage laws
Minimum agricultural prices
Governments & markets
slide 6
AN IMPORTANT TAX
PROBLEM
Suppose the market for cigarettes is in
equilibrium.
Suppose the State of Michigan, in its wisdom,
decides to impose a tax of $1 per pack on
the sale of cigarettes.
How does the tax affect the market for
cigarettes?
Governments & markets
slide 7
This kind of tax can be analyzed as if it were
an input price increase. The tax is similar to
having to pay a higher price for some input
(government services?).
The tax will raise the supply curve by the
amount of the tax per unit.
Governments & markets
slide 8
The tax raises the supply curve by the
amount of the tax per unit
S + tax
S
price
This distance is
exactly $1.
pE
D
QE
Q
CIGARETTE MARKET
Governments & markets
slide 9
The reason the supply curve shifts up by
exactly the amount of the tax is that price
would have to rise by the full amount of the
tax to induce cigarette suppliers to supply
the amount they supplied before the tax.
Governments & markets
slide 10
But price will rise by less than the amount of
the tax, as the following diagram shows.
Go to hidden slide
Governments & markets
slide 11
The state’s tax revenue is $1 times the
number of units sold.
P
total tax collections
S + tax
S
pE’
D
QE’
QE
Q
CIGARETTE MARKET
Governments & markets
slide 13
Tax Burden
The tax burden on consumers is the part of the
tax paid by consumers in terms of higher
prices.
The tax burden on sellers is the part of the tax
paid by firms in terms of lower receipts.
Governments & markets
slide 14
Who pays the tax on cigarettes?
P
S+Tax
Tax per
unit
S
D
Q
Go to hidden slide
Governments & markets
slide 15
Tax burden on each is determined by the
elasticities of supply and demand.
Governments & markets
slide 17
Given the demand curve, more elastic (flatter)
supply means greater tax burden for
consumers.
Given the supply curve, more elastic (flatter)
demand means greater tax burden for
sellers.
[Hint: Don't try to memorize these statements. Instead, make sure you
can figure out each case.]
Governments & markets
slide 18
Elasticity also determines the
state's tax revenue.
For example:
1) The more inelastic is the demand curve,
the greater will be the state’s tax revenue.
2) The more inelastic is the supply curve,
the greater will be the state’s tax revenue.
Governments & markets
slide 19
The next (hidden) slide shows these principles
for different elasticities of demand.
When demand is more elastic:
Price rises less.
There's relatively more burden on sellers.
The state takes in less revenue.
Go to hidden slide
Governments & markets
slide 20