In this chapter, look for the answers to these questions:

• What are price ceilings and price floors?

What are some examples of each?
Chapter 3 • How do price ceilings and price floors affect market
Supply, demand and government policies outcomes?
• How do taxes affect market outcomes?
How does the outcome depend on whether
Le Thi Kim Dung, M.E the tax is imposed on buyers or sellers?
• What is the incidence of a tax?
What determines the incidence?

4.1

Government Policies That Alter the Private Market EXAMPLE 1: The Market for Apartments
Outcome
• Price controls
Rental P S
– Price ceiling: a legal maximum on the price
of a good or service. Example: rent control. price of
apts
– Price floor: a legal minimum on the price of
a good or service. Example: minimum wage. $800
Eq’m w/o
• Taxes
price
– The govt can make buyers or sellers pay a specific
controls
amount on each unit bought/sold.
D
Q
We will use the supply/demand model to see 300
how each policy affects the market outcome Quantity of
(the price buyers pay, the price sellers receive, apartments
and eq’m quantity). 4.2 4.3

How Price Ceilings Affect Market Outcomes How Price Ceilings Affect Market Outcomes

A price ceiling P The eq’m price P

above the S S
Price ($800) is above
eq’m price is $1000 the ceiling and
ceiling
not binding – therefore illegal.
it has no effect $800 The ceiling $800
on the market is a binding
outcome. Price
constraint $500
ceiling
on the price, and shortage
D causes D
Q a shortage. Q
300 250 400

4.4 4.5

1
 How Price Ceilings Affect Market Outcomes EXAMPLE 2: The Market for Unskilled Labor

In the long run, P S Wage W S

supply and paid to
demand unskilled
are more workers
$800 $4
price-elastic.
So, the shortage Price Eq’m w/o
$500
is larger. ceiling price
shortage controls
D D
Q L
150 450 500
Quantity of
unskilled workers
4.6 4.7

How Price Floors Affect Market Outcomes How Price Floors Affect Market Outcomes
labor
A price floor W The eq’m wage ($4) is W surplus S
below the S below the floor and Price
eq’m price is therefore $5
floor
not binding – illegal.
it has no effect $4 The floor $4
on the market is a binding constraint
outcome. Price on the wage,
$3
floor and causes
a surplus
D (i.e., unemployment). D
L L
500 400 550

4.8 4.9

The Minimum Wage

Min wage laws unemp-
Taxes
do not affect W loyment S • The govt levies taxes on many goods &
highly skilled Min.
$5
wage services to raise revenue to pay for national
workers.
defense, public schools, etc.
They do affect $4
teen workers. • The govt can make buyers or sellers pay the
Studies: tax.
A 10% increase
in the min wage D • The tax can be a percentage of the good’s
raises teen L
400 550 price, or a specific amount for each unit
unemployment sold.
by 1-3%.
– For simplicity, we analyze per-unit taxes only.
4.10 4.11

2
 EXAMPLE 3: The Market for Pizza A Tax on Buyers
A tax on
buyers shifts Effects of a $1.50 per
Eq’m the D curve unit tax on buyers
w/o tax P P
down by the
S1 amount of S1
PB = $11.00
the tax. Tax
$10.00 $10.00
PS = $9.50
The price
buyers pay
D1 D1
rises, the
price sellers D2
Q receive falls, Q
500 430 500
eq’m Q falls.
4.12 4.13

The Incidence of a Tax: A Tax on Sellers

how the burden of a tax is shared among A tax on
sellers shifts Effects of a $1.50 per
market participants
the S curve unit tax on sellers
P P S2
up by the
S1 amount of S1
PB = $11.00 Tax PB = $11.00 Tax
Because the tax.
of the tax, $10.00 $10.00
buyers pay PS = $9.50 PS = $9.50
The price
$1.00 more, buyers pay
D1 D1
sellers get rises, the
$0.50 less. D2 price sellers
Q receive falls, Q
430 500 430 500
eq’m Q falls.
4.14 4.15

The Outcome Is the Same in Both Cases!

The effects on P and Q, and the tax incidence are the Elasticity and Tax Incidence
same whether the tax is imposed on buyers or sellers! CASE 1: Supply is more elastic than demand

What matters P P In this case,

is this: S1 buyers bear
PB = $11.00 PB S
A tax drives Tax Buyers’ share most of the
a wedge $10.00 of tax burden burden of
Tax
between the PS = $9.50
Price if no tax the tax.
price buyers
pay and the D1 Sellers’ share PS
price sellers of tax burden
receive. Q D
430 500 Q

4.16 4.17

3
 Elasticity and Tax Incidence CASE STUDY: Who Pays the Luxury Tax?
CASE 2: Demand is more elastic than supply The market for yachts Demand is
price-elastic.
P In this case, P
S S
sellers bear In the short run,
Buyers’ share most of the Buyers’ share
of tax burden PB of tax burden PB supply is inelastic.
burden of
Price if no tax the tax. Hence,
Tax Tax
companies
Sellers’ share Sellers’ share
that build
of tax burden PS of tax burden PS
D D yachts pay
most of
Q Q the tax.

4.18 4.19