Week 5

Government policies
Price controls
 Price ceiling (or, price cap)
 Price floor (or, price support)

Quantity controls
 Production quota

Per unit tax (or, per unit subsidy)

 On the production (or, on the consumption) of a product
 On imports, or on exports

Price ceiling (or, Price cap)

…is a legal maximum on the price at which a good can be sold.
 The product price can be either at the price cap itself, or below it
 The product price cannot legally be above this price cap
 For example, a rent control on housing
b) quantity brought is equal quantity supplied (Q3)

Side-effect of price ceiling

 Income rise, and rents don’t
 Black-market activities
Price floor (or, Price support)
…is a legal minimum on the price at which a good can be sold.
 The product can be either at the price support itself, or above it.
 The product price cannot legally be below this price cap.
 Price support policies are intended to benefit the producers.
Example: agriculture
b) quantity brought is equal quantity demanded (Q5
Quantity controls
Production Quota
…is a legal maximum on the quantity at which a good can be produced. It is a form of quantity
control by the government.
 This is usually implying that the government considers that the free-market production
level is too high, and would like to limit the production of that good –by setting a
production quota
 The total quantity brought into the market cannot exceed this amount.
Per unit tax
 A per unit tax is an amount of money that is imposed by the government on each unit of
the good that is bought/sold.
Note: A per unit tax is not the same as a sales tax (which is a proportional tax)
 A tax on a particular product (says, cars) will make cars more expensive for buyers –
regardless of whether the tax is imposed on buyers (when they buy a car), or imposed
on sellers (when they sell a car).
Note: A subsidy is the opposite of a tax. Therefore, a subsidy can be analyzed like a
“negative tax” using the same economic tools.

 A per unit tax on a product reduces the market equilibrium quantity bought/sold
 The price paid by the buyers rises, but the price received by the sellers falls.
 The difference between the two prices is equal to the amount of the per unit tax, and is
called the tax wedge.
 The tax burden is shared between the consumers and producers of the product (as long
as the demand curve is downward-sloping and the supply curve is upward-sloping)