Chapter 6

Black market

A rent ceiling also encourages illegal trading in a black market, an illegal market in which the equilibrium price exceeds the price ceiling

Price ceiling

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 ceiling set above the equilibrium price has no effect, it does not constrain the market forces. A price ceiling below the equilibrium price has powerful effects on the market, it attempts to prevent the price from regulating the quantities demanded and supplied. When a price ceiling is applied to a housing market, it is called a rent ceiling. A rent ceiling set below the equilibrium rent creates: A housing shortage, increased search activity, and a black market.

Production quotas

A production quota is an upper limit to the quantity of a good that may be produced in a specified period. The effect of a production quota depends on whether it is set below or above the equilibrium quantity. Below has big effects: decrease in supply, rise in price, decrease in marginal cost, inefficiency, an incentive to cheat and overproduce

Inefficiency of a rent ceiling

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.

Subsidies

A subsidy is a payment made by the government to a producer. The effects of a subsidy are an increase in supply, a fall in price and increase in quantity produced, an increase in marginal cost, payments by governments to farmers, inefficient overproduction

Tax on buyers

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 this new demand curve, we subtract the tax from the maximum price that buyers are willing to pay for each quantity bought

Tax on sellers

A tax on sellers is like a rise in their cost, 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

Minimum wage and unemployment

At a wage rate above the equilibrium wage, the quantity of labor supplied exceeds the quantity of labor demanded and there is a surplus of labor. The demand for labor determines the level of employment, and the surplus of labor is unemployed

Taxes and efficiency

Because a tax drives a wedge between the price buyers pay and the price sellers receive, it results in inefficient underproduction. A tax makes marginal social benefit exceed marginal social cost, shrinks the producer surplus and consumer surplus, and creates a deadweight loss

Perfectly elastic supply

Because the equilibrium quantity decreases, there is underproduction and a deadweight loss arises. A deadweight loss arises from a tax when supply is not perfectly inelastic and is largest when supply is perfectly elastic. The more elastic the supply, the more is paid by buyers

Perfectly elastic demand

Because the equilibrium quantity decreases, there is underproduction and deadweight loss. Deadweight loss arises from a tax when demand is not perfectly inelastic and is largest when demand is perfectly elastic. The more inelastic the demand, the larger is the amount paid by buyers

Perfectly inelastic supply

Because the equilibrium quantity doesn't change, there is no underproduction and deadweight loss arising from a tax when supply is perfectly inelastic

Perfectly inelastic demand

Because the equilibrium quantity doesn't change, there is no underproduction and no deadweight loss from the tax when demand is perfectly inelastic

Housing shortage

In a housing market, when the rent is at the equilibrium level, the quantity of housing supplied equals the quantity of housing demanded and there is neither a shortage nor a surplus of housing. But at a rent set below the equilibrium rent, the quantity of housing demanded exceeds the quantity of housing supplied and there is a shortage

The ability-to-pay principle

The ability-to-pay principle is the proposition that people should pay taxes according to how easily they can bear the burden of the tax. A rich person can more easily bear the burden than a poor person

The benefits principle

The benefits principle is the proposition that people should pay taxes equal to the benefits they receive from the services provided by the government. This arrangement is fair because it means that those who benefit most pay the most taxes. Rich may benefit more than the poor

Tax incidence

The division of the burden of a tax between buyers and sellers. When the government imposes a tax on the sale of a good (or service or a factor of production), the price buyers pay might rise by the full amount of the tax, by a lesser amount, or not at all. If the price buyers pay rises by the full amount of the tax, then the burden of the tax falls entirely on buyers. If the price buyers pay rises by a lesser amount than the tax, then the burden of the tax falls partly on buyers and sellers. And if the price buyers pay doesn't change at all, then the burden of the tax falls entirely on sellers

Inefficiency of a minimum wage

The minimum wage frustrates the market mechanism and results in unemployment and increased job search. At the quantity of labor employed, the marginal social benefit of labor exceeds its marginal social cost and a deadweight loss shrinks the firm's surplus and the workers' surplus

Tax influence of the elasticity of demand

To see how the elasticity of demand influences the division of the tax between buyers and sellers, we'll look at two extreme cases: Perfectly inelastic demand-buyers pay, and perfectly elastic demand-sellers pay

Tax influence on the elasticity of supply

To see how the elasticity of supply influences the division of the tax between buyers and sellers, we'll look again at two extreme cases: Perfectly inelastic supply-sellers pay, and perfectly elastic supply-buyers pay

Taxes

When a transaction is taxed, there are two prices: the price that includes the tax and the price that excludes the tax. Buyers respond to the price that includes the tax and sellers respond to the price that excludes the tax

Minimum wage

When wage rates are low, or when they fail to keep up with rising prices, labor unions might turn to governments and lobby for a higher wage rate. A government regulation that makes it illegal to charge a price lower than a specified level is called a price floor. A price floor set below the equilibrium price has no effect, it does not constrain the market forces. But a price floor set above the equilibrium price has powerful effects on a market, it attempts to prevent the price from regulating the quantities demanded and supplied. When a price floor is applied to a labor market, it is called a minimum wage. A minimum wage imposed at a level that is above the equilibrium wage creates unemployment