Questions for Review

1. Give an example of a price ceiling and an example of a price floor.

An example of a price ceiling is rent. In this case, the government sets the maximum price that landlords can charge
for a flat that they rent out to tenants.

An example of a price floor is minimum wage. This determines the lowest wage that firms must give to their
employees in exchange for their work.

2. Which causes a shortage of a good—a price ceiling or a price floor? Justify your answer with a graph.

Price ceiling

3. What mechanisms allocate resources when the price of a good is not allowed to bring supply and demand
into equilibrium?

Government regulations often move the market out of equilibrium. When a price ceiling is imposed, the price is
under the equilibrium which results in a shortage. When there is a price floor, the price is above the equilibrium which
causes a surplus.In these cases, the market has to make some rationing mechanisms

4. Explain why economists usually oppose controls on prices.

The reason most economists oppose price control is due to the allocation of resources. Price ceilings prevent the
prices from breaking the maximum as this creates shortages. Price floors prevent the prices from being below the
minimum since they create surpluses.

5. Suppose the government removes a tax on buyers of a good and levies a tax of the same size on sellers of
the good. How does this change in tax policy affect the price that buyers pay sellers for this good, the
amount buyers are out of pocket (including any tax payments they make), the amount sellers receive (net of
any tax payments they make), and the quantity of the good sold?

The outcome will not change significantly. There will be a new equilibrium price and quantity so buyers will have to
give more for good while sellers will pay less. So the tax, whether given to buyers or given to sellers, will not change
the outcome.

6. How does a tax on a good affect the price paid by buyers, the price received by sellers, and the quantity
sold?

A tax on a good raises the price buyers pay, lowers the price sellers receive, and reduces the quantity sold.

7. What determines how the burden of a tax is divided between buyers and sellers? Why?

The burden of a tax is divided between buyers and sellers depending on the elasticity of demand and supply.
Elasticity represents the willingness of buyers or sellers to leave the market.

Multiple Choice Questions

1. When the government imposes a binding price floor, it causes

d. A surplus of the good to develop.

2. In a market with a binding price ceiling, an increase in the ceiling will ___________ the quantity supplied,
___________ the quantity demanded, and reduce
the ___________.

c. Increase, decrease, shortage.

3. A $1 per unit tax levied on consumers of a good is equivalent to

a. A 1 per unit tax levied on producers of the good.

4. Which of the following would increase quantity sup- plied, decrease quantity demanded, and increase the price that
consumers pay?

a. The imposition of a binding price floor.

5. Which of the following would increase quantity sup- plied, increase quantity demanded, and decrease the price that
consumers pay?

d. The repeal of a tax levied on producers.

6. When a good is taxed, the burden of the tax falls mainly on consumers if

d. Supply is elastic, and demand is inelastic.

Problems and Applications

1. Lovers of classical music persuade Congress to impose a price ceiling of $40 per concert ticket. As a result
of this policy, do more or fewer people attend classical music concerts? Explain.

The government's $40 price limit will reduce attendance at the concert. This means that in addition to high demand,
there will be fewer delivered tickets. The number of tickets delivered will reduce concert viewership due to the limited
price set by the government.

2. The government has decided that the free-market price of cheese is too low.

a) This means that there is a surplus in cheese

b) It is possible that producers get a smaller total revenue even though they receive a higher price for each unit
of the good.
c) The losers of this policy are the government or the taxpayers and the winners are the suppliers

3. A recent study found that the demand and supply schedules for Frisbees are as follows:

a) The equilibrium quantity of Frisbees is 6 million, and the equilibrium price of Frisbees is $8 per Frisbee.
b) Increasing the price by two dollars makes the market price to be 10 dollars. The demanded quantity will
be only two million while the supply will be 12 million, which means that 2 million have been sold. There
remains a surplus of 10 million.
c) If the price ceiling is set $1 below the old price floor, the new market price for Frisbees is $9. Now there is
an excess supply of 5 million frisbees.
4. Suppose the federal government requires beer drink- ers to pay a $2 tax on each case of beer purchased. (In fact,
both the federal and state governments impose beer taxes of some sort.)

a) The price received by producers and the price paid by consumers is equal.

b) There is a two dollar difference between the price paid by consumers and the
price received by producers. Consumers are paying more than producers are receiving. The quantity sold
decreases.

5. A senator wants to raise tax revenue and make work- ers better off. A staff member proposes raising the payroll
tax paid by firms and using part of the extra revenue to reduce the payroll tax paid by workers. Would this accomplish
the senator’s goal? Explain.

Increasing the payroll tax paid by firms and using part of the extra revenue to decrease the payroll tax paid by
workers would not accomplish the senator's goal - workers would not be better off. It doesn't matter who pays the tax
when we talk about the division of a burden of a tax. The factor that we need to observe is the elasticity of supply and
demand. Since with the new tax policy a tax wedge would be greater, workers would not be better off (the same
applies for firms).

6. If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than $500, less
than $500, or exactly $500? Explain.

A new 500 dollar tax on luxury cars. The price paid by consumers will increase by less than 500 dollars. Because
the tax burden divides both sides. It also depends on the supply curve and its elasticity, so consumers are obliged to
pay a tax of 500 dollars.

7. Congress and the president decide that the United States should reduce air pollution by reducing its use of
gasoline. They impose a $0.50 tax on each gallon of gasoline sold.

a) Imposing the tax on either producers or consumers would not matter, in fact, you
should impose it on both to create the largest impact. If producers are making less and consumers are
paying more then the same effect takes place.

b) If demand is more elastic then the tax will have more of an effect, making consumers
purchase less gas.
 c) With the tax, gasoline consumers have to pay more than without the tax. They are also able to buy less
gasoline than before. Therefore, they are hurt by the tax.
d) Lower gasoline production will reduce the workforce in the oil industry. The smaller amount will also affect
the low incomes of employees, so the tax will certainly affect the workers in the oil industry negatively.
8. A case study in this chapter discusses the federal minimum-wage law.

a)
b) it can be concluded that the higher minimum wage causes lower employment . Also, in conditions that the
minimum wage is imposed above the equilibrium wage, the change in employment depends only on the
elasticity of demand . That means that in conditions of inelastic demand, the number of employees is higher,
due to the fact that employers have fewer choices in hiring employees.
c) In contrast to the conclusion given in the previous part of the task, it can be concluded that the higher
minimum wage causes higher unemployment. However, the changes in unemployment depend both on the
elasticity of demand and the elasticity of supply.
d) Due to the conclusion given in the second part (b) of the task, as the number of employees is higher in
conditions of inelastic demand, total wage payments to unskilled workers would also increase. On the
contrary, in conditions of elastic demand, the number of employees is lower, so that total wage payments to
unskilled workers would also decrease.
9. At Fenway Park, home of the Boston Red Sox, seating is limited to 39,000. Hence, the number of tickets issued is
fixed at that figure. Seeing a golden opportunity to raise revenue, the City of Boston levies a per ticket tax of $5 to be
paid by the ticket buyer. Boston sports fans, a famously civic-minded lot, dutifully send in the $5 per ticket. Draw a
well-labeled graph show- ing the impact of the tax. On whom does the tax bur- den fall—the team’s owners, the fans,
or both? Why?

The owners of the park receive less because the tax is going to the City of Boston, so now
instead of receiving the total of the ticket, $5 dollars off every ticket sold goes to the City instead of the owner.

10. A subsidy is the opposite of a tax. With a $0.50 tax on the buyers of ice-cream cones, the government collects
$0.50 for each cone purchased; with a $0.50 subsidy for the buyers of ice-cream cones, the government pays buyers
$0.50 for each cone purchased.

a)
b) The consumer and producer both lose from this, though not as much if there wasn’t a subsidy.