Chapter 6: Supply, Demand, and Government Policies

Which of the following statements is true if the government places a price ceiling on gasoline at $4.00 per gallon and the equilibrium price is $3.00 per gallon?

A significant increase in the demand for gasoline could cause the price ceiling to become a binding constraint.

Why is a tax collected from the buyers equivalent to a tax collected from the sellers?

A tax places a wedge between what the buyer pays and the seller receives. Whether the buyer or the seller actually hands the tax to the government makes no difference whatsoever.

TRUE / FALSE 1. If the equilibrium price of gasoline is $3.00 per gallon and the government places a price ceiling on gasoline of $4.00 per gallon, the result will be a shortage of gasoline.

F; a price ceiling set above the equilibrium price is not binding.

6. A 10 percent increase in the minimum wage causes a 10 percent reduction in teenage employment.

F; it causes a 1 to 3 percent reduction in employment.

2. A price ceiling set below the equilibrium price causes a surplus.

F; it causes a shortage

8. A price floor in a market always creates a surplus in that market.

F; it creates a surplus only if the floor is set above the equilibrium price.

5. The minimum wage helps all teenagers because they receive higher wages than they would otherwise.

F; some may be helped but others become un- employed and still others quit school to earn what appears to a teenager to be a good wage

15. The government can choose to place the burden of a tax on the buyers in a market by collecting the tax from the buyers rather than the sellers.

F; the burden of a tax is determined by the relative elasticities of supply and demand.

9. A $10 tax on baseball gloves will always raise the price that the buyers pay for baseball gloves by $10.

F; the difference between what the sellers receive and the buyers pay will be $10, but the price

12. If medicine is a necessity, the burden of a tax on medicine will likely land more heavily on the buyers of medicine.

F; we shift the demand curve downward by the size of the tax.

a. In response to lobbying by the Bicycle Riders Association, Congress places a price ceiling of $700 on bicycles. What effect will this have on the market for bicycles? Why?

It will have no effect. The price ceiling is not binding because the equilibrium price is $500 and the price ceiling is set at $700.

c. Does a price ceiling of $400 on bicycles make all bicycle buyers better off? Why or why not?

No. It may make those bicycle buyers better off that actually get a bicycle. However, some buyers are unable to get a bike, must wait in line, pay a bribe, or accept a lower quality bicycle.

Can the government legislate that the burden of a food tax will fall only on the sellers of food? Why or why not?

No. The tax burden is determined by the elastic- ity of supply and demand. The burden of a tax falls most heavily on the side of the market that is less elastic. That is, the burden is on the side of the market least willing to leave the market when the price moves unfavorably.

b. In response to lobbying by the Bicycle Riders Association, Congress places a price ceiling of $400 on bicycles. Use the information provided above to plot the supply and demand curves for bicycles in Exhibit 1. Impose the price ceiling. What is the result of a price ceiling of $400 on bicycles?

See Exhibit 5. The quantity demanded rises to 55 units, the quantity supplied falls to 40 units, and there is a shortage of 15 units.

d. Suppose instead, in response to lobbying by the Bicycle Manufacturers Association, Congress imposes a price floor on bicycles of $700. Use the information provided above to plot the supply and demand curves for bicycles in Exhibit 2. Impose the $700 price floor. What is the result of the $700 price floor?

See Exhibit 6. The quantity supplied rises to 70 units, the quantity demanded falls to 40 units, and there is a surplus of 30 units

Plot the supply and demand curves for bicycles in Exhibit 3. On the graph, impose a tax of $300 per bicycle to be collected from the sellers. After the tax, what has happened to the price paid by the buyers, the price received by the sellers, and the quantity sold when compared to the free market equilibrium?

See Exhibit 7. The price paid by the buyers rises to $700, the price received by the sellers falls to $400, and the quantity sold falls to 40 units.

Again, plot the supply and demand curves for bicycles in Exhibit 4. On the graph, impose a tax of $300 per bicycle to be collected from the buyers. After the tax, what has happened to the price paid by the buyers, the price received by the sellers, and the quantity sold when compared to the free market equilibrium?

See Exhibit 8. The price paid by the buyers rises to $700, the price received by the sellers falls to $400, and the quantity sold falls to 40 units.

10. The ultimate burden of a tax lands most heavily on the side of the market that is less elastic.

T

11. If medicine is a necessity, the burden of a tax on medicine will likely land more heavily on the buyers of medicine.

T

13. A tax collected from buyers has an equivalent impact to a same size tax collected from sellers.

T

14. A tax creates a tax wedge between a buyer and a seller. This causes the price paid by the buyer to rise, the price received by the seller to fall, and the quantity sold to fall.

T

3. A price floor set above the equilibrium price is a binding constraint.

T

4. The shortage of housing caused by a binding rent control is likely to be more severe in the long run when compared to the short run.

T

7. A price ceiling that is not a binding constraint today could cause a shortage in the future if demand were to increase and raise the equilibrium price above the fixed price ceiling.

T

Do you think the burden of a food tax will tend to fall on the sellers of food or the buyers of food? Why?

The burden will fall most heavily on the buy- ers of food regardless of whether the tax is col- lected from the buyers or the sellers. Food is a necessity, and therefore, the demand for food is relatively inelastic. When the price rises due to the tax, people still must eat. Grocery chains can sell another product lines when the price they receive for food falls due to the tax.

When we use the model of supply and demand to analyze a tax that is collected from the buyers, which way do we shift the demand curve? Why?

The demand curve is shifted downward by the size of the tax because the amount the buyer is willing to offer the seller has been reduced pre- cisely by the size of the tax.

Which of the following statements about the burden of a tax is correct?

The distribution of the burden of a tax is determined by the relative elasticities of supply and demand and is not determined by legislation.

Is the impact of a binding price ceiling greater in the short run or the long run? Why?

The impact is greater in the long run because both supply and demand tend to be more elastic in the long run. As a result, the shortage becomes more severe in the long run.

Suppose the equilibrium price for apartments is $800 per month and the government imposes rent controls of $500. Which of the following is unlikely to occur as a result of the rent controls?

The quality of apartments will improve

What is the impact on the price and quantity in a market if a price ceiling is set below the equilibrium price?

The quantity supplied decreases and the quantity demanded increases, causing a shortage.

What is the impact on the price and quantity in a market if a price floor is set above the equilibrium price?

The quantity supplied increases, and the quantity demanded decreases, causing a surplus.

Suppose a gas-guzzler tax is placed on luxury automobiles. Who will likely bear the greater burden of the tax, the buyers of luxury autos or the sellers? Why?

The sellers will bear the greater burden because the demand for luxuries tends to be highly elas- tic. That is, when the price buyers pay rises due to the tax, wealthy buyers can easily shift their purchases toward alternative items while pro- ducers cannot quickly reduce production when the price they receive falls. The burden falls on the side of the market that is less elastic.

Which of the following statements about a binding price ceiling is true?

The shortage created by the price ceiling is greater in the long run than in the short run.

When we use the model of supply and demand to analyze a tax that is collected from the sellers, which way do we shift the supply curve? Why?

The supply curve is shifted upward by the size of the tax because the amount the seller requires from the buyer has been increased by precisely the size of the tax.

Short Answer. 1. What is the impact on the price and quantity in a market if a price ceiling is set above the equilibrium price? Why?

There is no impact because the price can move to equilibrium without restriction. That is, the price ceiling is not a binding constraint.

What is the impact on the price and quantity in a market if a price floor is set below the equilibrium price? Why?

There is no impact because the price can move to equilibrium without restriction. That is, the price floor is not a binding constraint.

What are some of the problems created by a binding price ceiling?

There will be a shortage, buyers may wait in lines, sellers may be able to discriminate among buyers, the quality of the product may be reduced, and bribes may be paid to sellers.

price ceiling

a legal maximum on the price at which a good can be sold

price floor

a legal minimum on the price at which a good can be sold

A binding price ceiling creates

a shortage.

Which of the following takes place when a tax is placed on a good?

an increase in the price buyers pay, a decrease in the price sellers receive, and a decrease in the quantity sold

Multiple Choice Questions For a price ceiling to be a binding constraint on the market, the government must set it

below the equilibrium price.

The surplus caused by a binding price floor will be greatest if

both supply and demand are elastic.

Studies show that a 10 percent increase in the minimum wage

decreases teenage employment by about 1 to 3 percent.

Within the supply-and-demand model, a tax collected from the buyers of a good shifts the

demand curve downward by the size of the tax per unit.

The burden of a tax falls more heavily on the sellers in a market when

demand is elastic and supply is inelastic.

The burden of a tax falls more heavily on the buyers in a market when

demand is inelastic and supply is elastic.

For which of the following products would the burden of a tax likely fall more heavily on the sellers?

entertainment

A tax placed on a good that is a necessity for consumers will likely generate a tax burden that

falls more heavily on buyers.

A tax of $1.00 per gallon on gasoline

places a tax wedge of $1.00 between the price the buyers pay and the price the sellers receive.

A price floor

sets a legal minimum on the price at which a good can be sold.

Within the supply-and-demand model, a tax collected from the sellers of a good shifts the

supply curve upward by the size of the tax per unit.

tax incidence

the manner in which the burden of a tax is shared among participants in a market

Which of the following is an example of a price floor?

the minimum wage.

Which side of the market is more likely to lobby government for a price floor?

the sellers

When a tax is collected from the buyers in a market,

the tax burden on the buyers and sellers is the same as an equivalent tax col- lected from the sellers.