Study Session 4 - Reading 15 Markets In Action

Sunday, August 24, 2008

11:19 AM
• A price ceiling is a law that requires the price not exceed a certain level. Always
placed below Equilibrium price
o Results in a shortage since quantity demanded will be less than quantity
supplied
o Sellers will seek to increase prices such as charging high prices for
exorbitant goods
o Black markets can pop up in housing
o Impedes the LR equilibrium between quantity demanded and supplied
• Prolongs effects of price shocks
• Price floors - makes it illegal to sell at a price lower than some specified level
o Minimum wage law
• Creates surplus of workers - deadweight loss and opportunity costs,
reduing social surplus
• Taxes - distort the market
o On sellers - increases their costs forcing them to supply less - Supply curve
shifts to the left. Demand is unchanged but quantity demanded goes lower
since price will be higher
o Tax incidence - how the tax burden is shared
• Statutory - who has legal obligation
• Actual - who bears most of the burden in reality
Supply/Demand Elasticity Tax Burden
Relationship
Demand more elastic than Sellers
supply
Demand more inelastic than Buyers
supply
• Size of deadweight loss
• Subsidies - payments the gov't makes to help defray production costs
o Increases the supply and shifts the supply curve to the right.
o Price falls increasing demand.
o On exam, find equilibrium level, subtract subsidy from price. Difference in
supply between original Eq level and new price level gets added to each
supply amount. Now find new Equilibrium level
• Quotas restrict total production
o Equilibrium quantity decreases and prices rise - Deadweight loss
o If given an exam question with quota and asked for price, use the quota
level
• Illegal Products
o If selling is illegal
• Breaking law cost is added to price. Supply decreases so price
increases.
o If buying is illegal
• Demand goes down so price will decrease
o If both illegal
• Demand and supply decrease so price may remain the same.
• BUT, if buyers pay penalty, price increases
• If sellers pay, price decreases