Chapter 6 Government actions in markets
1. Explain how rent ceilings create housing shortages and inefficiency
A government regulation that makes it illegal to charge a price higher than a specified level is called a
price ceiling or price cap. The effects of a price ceiling on a market depend crucially on whether the
ceiling is imposed at a level that is above or below the equilibrium price. A price set above the
equilibrium price has no effect. The reason s that the price ceiling does not constrain the market
forces. The price ceiling below the equilibrium price has powerful effects on the market. The reason
is that the price ceiling attempts to prevent the price from regulating the quantities demanded and
supplied. The rent ceilings set below the equilibrium rent creates:
A housing shortage
Increased search activity
A black market
When the rent is set below the equilibrium rent, the quantity of housing demanded exceeds the
quantity of housing supplied – there is a shortage. So if a rent ceiling is set below the equilibrium
rent, there is a shortage. Without price ceiling, the price would rise. But with the price ceiling the
quantity supplied must somehow be allocated among the frustrated demanders. One way is through
increased search activity. The time spent looking for someone with whom to do business. We spend
more time looking at the alternatives to find the best prices. The opportunity costs of a good is
equal not only to its price but also to the value of the search time spent finding the good. A rent
ceiling also encourages illegal trading in a black market, an illegal market in which the equilibrium
price exceeds the price ceiling. With loose enforcement the black market is close to the unregulated
rent. But with strict enforcement, the black market rent is equal to the maximum price that a
renter is willing to pay. A rent ceiling set below the equilibrium rent results in an inefficient
underproduction of housing services. The marginal social benefit of housing exceeds its marginal
social cost and a deadweight loss shrinks the producer surplus and consumer surplus. There is a
deadweight loss when the quantity supplied is less than the efficient quantity.
Rent ceilings allocate scarce housing to the poorest but blocking rent adjustments doesn’t eliminate
scarcity. But when the rent is not permitted to allocate scarce housing, what other mechanisms are
available and are they fair? Three possible mechanisms are
A lottery
First come – first served
Discrimination
A lottery allocates housing to those who are lucky, not to those who are poor. First come, first served
allocated housing in England after the Second World War to those with the foresight to get their
names on a list first, not to the poorest. Discrimination allocates scarce housing based on the views
and the self-interest of owners. Discrimination based on friendship, family ties and criteria such as
race, sex or ethnicity is more likely to enter the equation.
2. Explain how minimum wage laws create unemployment and inefficiency
Firms decide how much labor to demand, and the lower the wage rate, the greater is the quantity
of labour demanded. Households decide how much labour to supply and the higher the wage rate,
the greater is the quantity supplied. A government imposed regulation that makes it illegal to charge
, a price lower than a specified level is called a price floor. The effects of a price floor on a market
depend crucially on whether the floor is imposed at a level that is above or below the equilibrium
price. A price floor set below the equilibrium price has no effect. The price floor above the
equilibrium price has powerful effects on a market. The reason is that the price floor attempts to
prevent the price from regulating the quantities demanded and supplied. When the price floor is
applied to a labour market, it is called a minimum wage. When the minimum age is set above the
equilibrium wage there is a surplus. In the labour market the supply curve measures the marginal
social cost of labour to workers. This cost is leisure forgone. The demand curve measures the
marginal benefit from labour. This benefit is the value of the goods and services produced.
3. Explain the effects of a tax
Everything you earn and almost everything you buy is taxed. You’re going to discover that it isn’t
obvious who really pays a tax and that lawmakers don’t make that decision. We begin with a
definition of tax incidence. The division of the burden of a tax between buyers and sellers.
1. The price paid by buyer can raise by the full amount of the tax, then the burden of the tax
falls entirely on buyers – buyers pay the tax
2. If the price paid by buyers rises by a lesser amount than the tax, then the burden of the tax
falls partly on buyers and partly on sellers.
3. If the price paid by buyers doesn’t change at all, then the burden of the tax falls entirely on
sellers.
A tax on sellers is like an increase in costs, so it decreases supply. To determine the position of the
new supply curve, we add the tax to the minimum price that sellers are willing to accept for each
quantity sold. Suppose that the government taxes buyers with 1.50 a pack. A tax on buyers lowers
the amount they are willing to pay sellers, so it decreases demand and shifts the demand curve
leftward. To determine the position of the new demand curve, we subtract the tax from the
maximum price that buyers are willing to pay for each quantity bought. When the transaction is
taxed, there are two prices; the price paid by buyers, which includes the tax; and the price received
by sellers, which excludes the tax. Buyers respond only to the price that includes the tax because that
is the price they pay. Sellers respond only to the price that excludes the ta because that is the price
they receive.
The division of the tax between buyers and sellers depend partly on the elasticity of demand. There
are two extreme case:
- Perfectly inelastic demand – buyers pay
Insulin, regardless of the price a diabetic would sacrifice all other goods and services rather than not
consume the quantity of insulin that provides good health. If insulin is taxed at 0,20 cents per bottle
we must add the tax to the minimum price at which drug companies are willing to sell insulin.
Buyers pay the entire tax of 0,20 cents
- Perfectly elastic demand – sellers pay
The market for pink marker pens because if pink markers are less expensive than other pens,
everyone uses pink. IF pink markers are more expensive, nobody uses pink. Suppose the government
raises a tax of 0,20 per pen. The price remains the same but the quantity supplied goes down. The
seller bears all the costs. The more inelastic the demand for a good, the larger is the amount of the
tax paid by buyers.
1. Explain how rent ceilings create housing shortages and inefficiency
A government regulation that makes it illegal to charge a price higher than a specified level is called a
price ceiling or price cap. The effects of a price ceiling on a market depend crucially on whether the
ceiling is imposed at a level that is above or below the equilibrium price. A price set above the
equilibrium price has no effect. The reason s that the price ceiling does not constrain the market
forces. The price ceiling below the equilibrium price has powerful effects on the market. The reason
is that the price ceiling attempts to prevent the price from regulating the quantities demanded and
supplied. The rent ceilings set below the equilibrium rent creates:
A housing shortage
Increased search activity
A black market
When the rent is set below the equilibrium rent, the quantity of housing demanded exceeds the
quantity of housing supplied – there is a shortage. So if a rent ceiling is set below the equilibrium
rent, there is a shortage. Without price ceiling, the price would rise. But with the price ceiling the
quantity supplied must somehow be allocated among the frustrated demanders. One way is through
increased search activity. The time spent looking for someone with whom to do business. We spend
more time looking at the alternatives to find the best prices. The opportunity costs of a good is
equal not only to its price but also to the value of the search time spent finding the good. A rent
ceiling also encourages illegal trading in a black market, an illegal market in which the equilibrium
price exceeds the price ceiling. With loose enforcement the black market is close to the unregulated
rent. But with strict enforcement, the black market rent is equal to the maximum price that a
renter is willing to pay. A rent ceiling set below the equilibrium rent results in an inefficient
underproduction of housing services. The marginal social benefit of housing exceeds its marginal
social cost and a deadweight loss shrinks the producer surplus and consumer surplus. There is a
deadweight loss when the quantity supplied is less than the efficient quantity.
Rent ceilings allocate scarce housing to the poorest but blocking rent adjustments doesn’t eliminate
scarcity. But when the rent is not permitted to allocate scarce housing, what other mechanisms are
available and are they fair? Three possible mechanisms are
A lottery
First come – first served
Discrimination
A lottery allocates housing to those who are lucky, not to those who are poor. First come, first served
allocated housing in England after the Second World War to those with the foresight to get their
names on a list first, not to the poorest. Discrimination allocates scarce housing based on the views
and the self-interest of owners. Discrimination based on friendship, family ties and criteria such as
race, sex or ethnicity is more likely to enter the equation.
2. Explain how minimum wage laws create unemployment and inefficiency
Firms decide how much labor to demand, and the lower the wage rate, the greater is the quantity
of labour demanded. Households decide how much labour to supply and the higher the wage rate,
the greater is the quantity supplied. A government imposed regulation that makes it illegal to charge
, a price lower than a specified level is called a price floor. The effects of a price floor on a market
depend crucially on whether the floor is imposed at a level that is above or below the equilibrium
price. A price floor set below the equilibrium price has no effect. The price floor above the
equilibrium price has powerful effects on a market. The reason is that the price floor attempts to
prevent the price from regulating the quantities demanded and supplied. When the price floor is
applied to a labour market, it is called a minimum wage. When the minimum age is set above the
equilibrium wage there is a surplus. In the labour market the supply curve measures the marginal
social cost of labour to workers. This cost is leisure forgone. The demand curve measures the
marginal benefit from labour. This benefit is the value of the goods and services produced.
3. Explain the effects of a tax
Everything you earn and almost everything you buy is taxed. You’re going to discover that it isn’t
obvious who really pays a tax and that lawmakers don’t make that decision. We begin with a
definition of tax incidence. The division of the burden of a tax between buyers and sellers.
1. The price paid by buyer can raise by the full amount of the tax, then the burden of the tax
falls entirely on buyers – buyers pay the tax
2. If the price paid by buyers rises by a lesser amount than the tax, then the burden of the tax
falls partly on buyers and partly on sellers.
3. If the price paid by buyers doesn’t change at all, then the burden of the tax falls entirely on
sellers.
A tax on sellers is like an increase in costs, so it decreases supply. To determine the position of the
new supply curve, we add the tax to the minimum price that sellers are willing to accept for each
quantity sold. Suppose that the government taxes buyers with 1.50 a pack. A tax on buyers lowers
the amount they are willing to pay sellers, so it decreases demand and shifts the demand curve
leftward. To determine the position of the new demand curve, we subtract the tax from the
maximum price that buyers are willing to pay for each quantity bought. When the transaction is
taxed, there are two prices; the price paid by buyers, which includes the tax; and the price received
by sellers, which excludes the tax. Buyers respond only to the price that includes the tax because that
is the price they pay. Sellers respond only to the price that excludes the ta because that is the price
they receive.
The division of the tax between buyers and sellers depend partly on the elasticity of demand. There
are two extreme case:
- Perfectly inelastic demand – buyers pay
Insulin, regardless of the price a diabetic would sacrifice all other goods and services rather than not
consume the quantity of insulin that provides good health. If insulin is taxed at 0,20 cents per bottle
we must add the tax to the minimum price at which drug companies are willing to sell insulin.
Buyers pay the entire tax of 0,20 cents
- Perfectly elastic demand – sellers pay
The market for pink marker pens because if pink markers are less expensive than other pens,
everyone uses pink. IF pink markers are more expensive, nobody uses pink. Suppose the government
raises a tax of 0,20 per pen. The price remains the same but the quantity supplied goes down. The
seller bears all the costs. The more inelastic the demand for a good, the larger is the amount of the
tax paid by buyers.
