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Notes
Controls on Prices
Price Ceiling a legal maximum on the price at which a good can be sold
Price Floor a legal minimum on the price at which a good can be sold
We are looking at how price controls affect market outcomes. Buyers of a good always want a lower price, i.e. a price ceiling, while sellers always want a higher price, i.e. a price floor. The interests of these two groups conflict and they will lobby government for price controls.
How Price Ceilings Affect Market Outcomes
If the equilibrium price is above the price ceiling, the price ceiling is a binding constraint on the market. Less of the product will be supplied while more of the product will be demanded. The market will now find new ways to allocate the scarce resource, i.e. the product. This might be through customers having to queue for long periods of time before purchasing the product or favouritism for certain customers from suppliers. Money is after all a measure of effort so the queuing is another, if not more inefficient, way of measuring this. The favouritism for certain customers from suppliers is a very inefficient and unfair method of allocating a scarce commodity. It does not take into account which buyers want the product the most or the effort they have made in order to obtain the product.
If the equilibrium price is below the price ceiling, the price ceiling is not binding and the market can reach the equilibrium of supply and demand.
A common example of a price ceiling in everyday life is rent control.
How Price Floors Affect Market Outcomes
If the equilibrium price of a good is below the price floor, the price floor is a binding constraint on the market. The forces of supply and demand will move toward the equilibrium price but when the market price hits the floor it can fall no further. More of the product will be supplied while less of the product will be demanded. Suppliers now have to find ways to sell their surplus stock. They might try to appeal to buyers’ personal biases or engage in aggressive marketing and branding campaigns. In contrast, in a free market these suppliers would be able to sell all of their stock a equilibrium price as the price serves as the rationing mechanism.
If the equilibrium price is above the price floor, it is not binding and the market can reach the equilibrium of supply and demand.
A common example of a price floor in everyday life is the minimum wage in the labour market.
Evaluating Price Controls
Principle 6: Markets Are Usually a Good Way to Organise Economic Activity
This explains why economists are usually opposed to price ceilings and price floors. When policy makers set prices by legal decree, they obscure the signals that normally guide the allocation of society’s resources.
Principle 7: Governments Can Sometimes Improve Market Outcomes
Price controls are often aimed at helping the poor, e.g. rent control. This, however, affects the market as a whole whereas if the government paid a fraction of the rent for poor families it would make housing more affordable for them while also ensuring that the market is allowed to function normally.
Taxes
Tax Incidence the division of a tax burden between buyers and sellers
How Taxes on Sellers Affect Market Outcomes
A tax on suppliers shifts the supply curve upwards by the amount of the tax while the demand curve remains the same. The tax on sellers raises the cost of producing and selling a product because for the same price the supplier actually receives less money. This reduces the quantity supplied at every price. The equilibrium price will rise and the equilibrium quantity will fall.
Elasticity and Tax Incidence
The incidence of a tax or subsidy depends on the price elasticities of supply and demand. The burden tends to fall on the side of the market that is less elastic because that side of the market can respond less easily to a tax or more easily to a subsidy. Elasticity measures the willingness of buyers and suppliers to leave a market when conditions become less favourable. When a good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must, therefore, bear more of the burden of the tax.
How Subsidies Affect Market Outcomes
A subsidy given to sellers lowers the cost of production and encourages firms to expand output. Buyers also benefit from lower prices. The supply curve will shift down and to the right while the demand curve will remain the same.
Price Ceiling a legal maximum on the price at which a good can be sold
Price Floor a legal minimum on the price at which a good can be sold
We are looking at how price controls affect market outcomes. Buyers of a good always want a lower price, i.e. a price ceiling, while sellers always want a higher price, i.e. a price floor. The interests of these two groups conflict and they will lobby government for price controls.
How Price Ceilings Affect Market Outcomes
If the equilibrium price is above the price ceiling, the price ceiling is a binding constraint on the market. Less of the product will be supplied while more of the product will be demanded. The market will now find new ways to allocate the scarce resource, i.e. the product. This might be through customers having to queue for long periods of time before purchasing the product or favouritism for certain customers from suppliers. Money is after all a measure of effort so the queuing is another, if not more inefficient, way of measuring this. The favouritism for certain customers from suppliers is a very inefficient and unfair method of allocating a scarce commodity. It does not take into account which buyers want the product the most or the effort they have made in order to obtain the product.
If the equilibrium price is below the price ceiling, the price ceiling is not binding and the market can reach the equilibrium of supply and demand.
A common example of a price ceiling in everyday life is rent control.
How Price Floors Affect Market Outcomes
If the equilibrium price of a good is below the price floor, the price floor is a binding constraint on the market. The forces of supply and demand will move toward the equilibrium price but when the market price hits the floor it can fall no further. More of the product will be supplied while less of the product will be demanded. Suppliers now have to find ways to sell their surplus stock. They might try to appeal to buyers’ personal biases or engage in aggressive marketing and branding campaigns. In contrast, in a free market these suppliers would be able to sell all of their stock a equilibrium price as the price serves as the rationing mechanism.
If the equilibrium price is above the price floor, it is not binding and the market can reach the equilibrium of supply and demand.
A common example of a price floor in everyday life is the minimum wage in the labour market.
Evaluating Price Controls
Principle 6: Markets Are Usually a Good Way to Organise Economic Activity
This explains why economists are usually opposed to price ceilings and price floors. When policy makers set prices by legal decree, they obscure the signals that normally guide the allocation of society’s resources.
Principle 7: Governments Can Sometimes Improve Market Outcomes
Price controls are often aimed at helping the poor, e.g. rent control. This, however, affects the market as a whole whereas if the government paid a fraction of the rent for poor families it would make housing more affordable for them while also ensuring that the market is allowed to function normally.
Taxes
Tax Incidence the division of a tax burden between buyers and sellers
How Taxes on Sellers Affect Market Outcomes
A tax on suppliers shifts the supply curve upwards by the amount of the tax while the demand curve remains the same. The tax on sellers raises the cost of producing and selling a product because for the same price the supplier actually receives less money. This reduces the quantity supplied at every price. The equilibrium price will rise and the equilibrium quantity will fall.
Elasticity and Tax Incidence
The incidence of a tax or subsidy depends on the price elasticities of supply and demand. The burden tends to fall on the side of the market that is less elastic because that side of the market can respond less easily to a tax or more easily to a subsidy. Elasticity measures the willingness of buyers and suppliers to leave a market when conditions become less favourable. When a good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must, therefore, bear more of the burden of the tax.
How Subsidies Affect Market Outcomes
A subsidy given to sellers lowers the cost of production and encourages firms to expand output. Buyers also benefit from lower prices. The supply curve will shift down and to the right while the demand curve will remain the same.
References
N Gregory Mankiw & Mark P Taylor, Economics, second edition, Cengage Learning, 2011
http://www.docstoc.com/docs/83301377/Price-Ceilings, Price Ceilings, 28th October 2012
First and second graphs: http://www.sparknotes.com/economics/micro/supplydemand/equilibrium/section2.rhtml, Effects of price ceiling and price floor on supply and demand, Spark Notes, 29th October 2012
Third graph: http://blog.truenorth.nu/2010/07/14/what-does-changing-the-federal-beer-tax-mean-for-californias-brewers/, Effect of tax on supply curve, Truenorth dot New, 29th October 2012
Fourth graph: http://www.economicsonline.co.uk/Competitive_markets/Subsidies.html, Effect of subsidy on supply curve, Economics Online, 29th October 2012
First picture: http://www.tirnasaor.com/07/09/what-is-money/, Money, 30th October 2012
Second picture: http://klobb.posterous.com/tricky-shuffle-algorithm-problem-please-help, Thinking Man, 30th October 2012
Third picture: http://econom-biz.blogspot.ie/2011/09/are-us-get-bankrupt.html, Poor, 30th October 2012
Fourth picture: http://blog.socialmaximizer.com/how-to-handle-social-media-and-pr-crisis/, Crisis, 30th October 2012
Fifth picture: http://angrymanofmolesey.blogspot.ie/2010/08/service-at-any-cost.html, Queuing, 30th October 2012
Sixth picture: http://www.sodahead.com/entertainment/honey-boo-boo-endorses-obama-do-you-agree/question-3252449/?page=9&link=ibaf&q=racism&imgurl=http://1.bp.blogspot.com/_A0G8x4YSZvw/TRSBkJtSTjI/AAAAAAAAR5g/ixRP3GVEpcY/s1600/SABM-RACISM01A.jpg, Racism, 30th October 2012
Seventh picture: http://esharingportal.com/favouritism-is-bad.html, Favouritism, 30th October 2012
Eighth picture: http://niallcooper.wordpress.com/2011/09/07/paying-tax-is-an-act-of-love/, Taxes, 30th October 2012
Ninth picture: http://sdpride.info/?tag=consumers-shift, Consumers, 30th October 2012
Tenth picture: http://www.sausageobsession.com/2011/07/dead-bodies-sausage-anthony-sowel/, Producers, 30th October 2012
Eleventh picture: Consumers, as ninth picture above
Twelfth picture: Producers, as tenth picture above
Thirteenth picture: http://www.transport21.ie/Projects/Heavy_Rail/Heavy_Rail.html, Rail Transport, 30th October 2012
Fourteenth picture: http://allthingsd.com/20120915/its-official-the-era-of-the-personal-computer-is-over/the-end-old-movie/, The End, 30th October 2012
http://www.docstoc.com/docs/83301377/Price-Ceilings, Price Ceilings, 28th October 2012
First and second graphs: http://www.sparknotes.com/economics/micro/supplydemand/equilibrium/section2.rhtml, Effects of price ceiling and price floor on supply and demand, Spark Notes, 29th October 2012
Third graph: http://blog.truenorth.nu/2010/07/14/what-does-changing-the-federal-beer-tax-mean-for-californias-brewers/, Effect of tax on supply curve, Truenorth dot New, 29th October 2012
Fourth graph: http://www.economicsonline.co.uk/Competitive_markets/Subsidies.html, Effect of subsidy on supply curve, Economics Online, 29th October 2012
First picture: http://www.tirnasaor.com/07/09/what-is-money/, Money, 30th October 2012
Second picture: http://klobb.posterous.com/tricky-shuffle-algorithm-problem-please-help, Thinking Man, 30th October 2012
Third picture: http://econom-biz.blogspot.ie/2011/09/are-us-get-bankrupt.html, Poor, 30th October 2012
Fourth picture: http://blog.socialmaximizer.com/how-to-handle-social-media-and-pr-crisis/, Crisis, 30th October 2012
Fifth picture: http://angrymanofmolesey.blogspot.ie/2010/08/service-at-any-cost.html, Queuing, 30th October 2012
Sixth picture: http://www.sodahead.com/entertainment/honey-boo-boo-endorses-obama-do-you-agree/question-3252449/?page=9&link=ibaf&q=racism&imgurl=http://1.bp.blogspot.com/_A0G8x4YSZvw/TRSBkJtSTjI/AAAAAAAAR5g/ixRP3GVEpcY/s1600/SABM-RACISM01A.jpg, Racism, 30th October 2012
Seventh picture: http://esharingportal.com/favouritism-is-bad.html, Favouritism, 30th October 2012
Eighth picture: http://niallcooper.wordpress.com/2011/09/07/paying-tax-is-an-act-of-love/, Taxes, 30th October 2012
Ninth picture: http://sdpride.info/?tag=consumers-shift, Consumers, 30th October 2012
Tenth picture: http://www.sausageobsession.com/2011/07/dead-bodies-sausage-anthony-sowel/, Producers, 30th October 2012
Eleventh picture: Consumers, as ninth picture above
Twelfth picture: Producers, as tenth picture above
Thirteenth picture: http://www.transport21.ie/Projects/Heavy_Rail/Heavy_Rail.html, Rail Transport, 30th October 2012
Fourteenth picture: http://allthingsd.com/20120915/its-official-the-era-of-the-personal-computer-is-over/the-end-old-movie/, The End, 30th October 2012