Price Controls...

Supply, Demand and

uAre usually enacted when
Government Policies policymakers believe the market
price is unfair to buyers or sellers.
uResult in government-created price
Chapter 6
ceilings and floors.
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Price Ceilings & Price Floors Price Ceilings

Price Ceiling Two outcomes are possible when the

uA legally established maximum price at which government imposes a price ceiling:
a good can be sold. u The price ceiling is not binding if set above
Price Floor the equilibrium price.
uA legally established minimum price at which a u The price ceiling is binding if set below the
good can be sold. equilibrium price, leading to a shortage.

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A Price Ceiling That Is Not Binding... A Price Ceiling That Is Binding...

Price of Price of
Ice-Cream Ice-Cream
Cone Cone
Supply Supply

Equilibrium
$4 Price price
ceiling

3 $3

Equilibrium 2 Price
price ceiling
Shortage

Demand Demand

0 100 Quantity of 0 75 125 Quantity of

Ice-Cream Ice-Cream
Equilibrium Quantity Quantity
quantity Cones Cones
supplied demanded

Effects of Price Ceilings Lines at the Gas Pump

In 1973 OPEC raised the price of
crude oil in world markets. Because
A binding price ceiling creates ... crude oil is the major input used to
… shortages because QD > QS. make gasoline, the higher oil prices
uExample: Gasoline shortage of the reduced the supply of gasoline.
1970s
… nonprice rationing What was responsible for the long
gas lines?
uExamples: Long lines, Discrimination
by sellers Economists blame government
regulations that limited the price oil
companies could charge for gasoline.
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 The Price Ceiling on Gasoline Is The Price Ceiling on Gasoline Is
Not Binding... Binding...
Price of Price of
S2 2. …but
Gasoline Gasoline when supply
falls...
1. Initially, Supply
the
S1
price ceiling P2
is not
binding... $4 Price Price
ceiling ceiling

P1 P1 3. …the price
ceiling becomes
4. …resulting binding...
in a shortage.

Demand Demand

0 Quantity of 0 Quantity of
Q1 Q1
Gasoline Gasoline
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Rent Control in the Short Run...

Rent Control Rental
Price of
uRent controls are ceilings placed on the Apartment Supply and
Supply demand for
rents that landlords may charge their apartments
tenants. are relatively
inelastic
uThe goal of rent control policy is to help
the poor by making housing more
Controlled rent
affordable.
Shortage
uOne economist called rent control “the
Demand
best way to destroy a city, other than
0 Quantity of
bombing.” Apartments

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 Rent Control in the Long Run...
Price Floors
Rental Because the
Price of supply and
Apartment
demand for
apartments are When the government imposes a
more elastic...
price floor, two outcomes are
Supply possible.
u The price floor is not binding if set below
…rent control the equilibrium price.
Controlled rent
causes a large
shortage u The price floor is binding if set above the
Shortage
Demand
equilibrium price, leading to a surplus.

0 Quantity of
Apartments

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A Price Floor That Is Not Binding... A Price Floor That Is Binding...

Price of Price of
Ice-Cream Ice-Cream
Cone Cone
Supply Supply
Surplus
Equilibrium
price $4 Price floor

$3 $3

Price
2 Equilibrium
floor price

Demand Demand

0 100 Quantity of 0 80 120 Quantity of

Equilibrium Ice-Cream Quantity Quantity
Cones Ice-Cream
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4
 Effects of a Price Floor
Effects of a Price Floor
A binding price floor causes . . .
uA price floor prevents supply and
demand from moving toward the … a surplus because QS >QD.
equilibrium price and quantity. … nonprice rationing is an alternative
uWhen the market price hits the mechanism for rationing the good,
floor, it can fall no further, and the using discrimination criteria.
market price equals the floor price. u Examples: The minimum wage, Agricultural
price supports

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The Minimum Wage

The Minimum Wage
A Free Labor Market
Wage
An important example of a Labor
supply
price floor is the minimum
wage. Minimum wage laws
dictate the lowest price Equilibrium
wage
possible for labor that any
employer may pay.
Labor
demand
0 Equilibrium Quantity of
employment Labor
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 The Minimum Wage
A Labor Market with a
Wage
Minimum Wage Taxes
Labor
Labor surplus supply
(unemployment)

Minimum
Governments levy taxes to
wage
raise revenue for public
projects.

Labor
demand
0 Quantity Quantity Quantity of
demanded supplied Labor
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Impact of a 50¢ Tax Levied on

Taxes Buyers...
uTax incidence refers to who bears Price of
Ice-Cream Supply, S1
the burden of a tax. Cone

uTaxes result in a change in market

3.00 A tax on buyers
equilibrium. shifts the demand
curve downward
uBuyers pay more and sellers receive by the size of
the tax ($0.50).
less, regardless of whom the tax is
levied on. D1
D2

0 100 Quantity of
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6
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Impact of a 50¢ Tax Levied on Impact of a 50¢ Tax on Sellers...

Buyers...
Price of
Price of Ice-Cream
Ice-Cream Cone A tax on sellers
Cone Supply, S1 Price S2 shifts the
Price buyers Equilibrium
supply curve
buyers pay with tax
pay upward by the
$3.30 Equilibrium without tax $3.30 S1 amount of the
Price 3.00 Tax ($0.50) 3.00 Tax ($0.50)
without Price tax ($0.50).
2.80 2.80
tax without
tax Equilibrium without tax

Price Price
Equilibrium
sellers with tax sellers
receive receive
D1
Demand, D 1
D2

0 90 100 Quantity of 0 90 100 Quantity of

Ice-Cream Cones Ice-Cream Cones

A Payroll Tax The Incidence of Tax

Wage
Labor uIn what proportions is the burden of
supply
the tax divided?
Wage firms
pay uHow do the effects of taxes on sellers
Wage Tax wedge
without tax
compare to those levied on buyers?
Wage workers
receive
The answers to these questions
Labor
demand depend on the elasticity of demand
0 Quantity of
and the elasticity of supply.
Labor
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 Elastic Supply, Inelastic Demand... Inelastic Supply, Elastic Demand...

Price 1. When demand is more

1. When supply is more Price
elastic than demand... elastic than supply...
Price buyers pay Supply
Price buyers pay
Supply
Price without tax 3. ...than on consumers.
Tax 2. ...the Tax
incidence of the
Price without tax tax falls more
heavily on Demand
Price sellers receive consumers... Price sellers receive 2. ...the
incidence of
Demand the tax falls more
3. ...than on heavily on producers...
producers.
0 Quantity 0 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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