ECON 2106 Chapter 6: Supply, Demand, & Gov. Policies

Price ceiling

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

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

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

Which of the following would increase Quantity supplied, increase quantity demanded, and decrease the price that consumers pay?

the repeal of a tax levied on producers

What happens if the local government passes a law requiring sellers of ice cream cones to send $0.50 to the government for every come they sell?

1) the immediate impact is on the sellers. The quantity demanded stays the same (demand curve stays the same) since the tax wasn't levied on the buyers. By contrast, the tax on the sellers makes business less profitable at any given price so it shifts the supply curve. 2) since the tax on sellers raises the cost of producing and selling, it reduces the quantity supplied at every price. The supply curve shifts to the left (or, equivalently, upward). For any market price of ice cream, the effective price to sellers— the amount they get to keep after paying the tax— is $0.50 lower. Whatever the market price, sellers will supply a quantity of ice cream as if the price were $0.50 lower than it is. Put differently, to induce sellers to supply any given quantity, the market price must now be $0.50 higher to compensate for the effect of the tax. 3) having determined how the supply curve shifts, we can now compare the initial and the new equilibrium. The equilibrium price of ice cream rises from $3 to $3.30, and the equilibrium quantity falls from 100 to 90 cones. Because sellers sell less and buyers buy less in the new equilibrium, the tax reduces the size of the ice cream market. Butter and sellers share the burden. Butter more pay $0.30 more for each ice cream cone than they did without the tax. Thus, the tax makes buyers worse off. Sellers get a higher price ($3.30) from buyers than they did previously, but what they get to keep after paying the tax is only $2.80 ($3.30-$0.50=$2.80), compared with $3 before the tax. Thus, the tax also makes sellers worse off.

What happens if the local government passes a law requiring buyers of ice cream cones to send $0.50 to the government for every come they buy?

1) the initial impact is on the demand for ice cream. The supply curve isn't affected because, for any given price of ice cream, sellers have the cane incentive to provide ice cream to the market. By contrast, buyers now have to pay a tax to the government (as well as the price to the sellers) whenever they buy ice cream. Thus, the tax shifts the demand curve for ice cream. 2) determine the direction of the shift. Because the tax on buyers makes buying ice cream less attractive, buyers demand a smaller quantity of ice cream at every price. As a result, the demand curve shifts to the left (or, equivalently, downward). The effective price to buyers is now $0.50 higher than the market price. Because buyers look at their total cost including the tax, the demand a quantity of ice cream as if the market price were B $0.50 higher than it actually is. In other words, to induce buyers to demand any given quantity, the market price must now be $0.50 lower to make up for the effect of the tax. Thus, the tax shifts the demand curve downward by the exact size of the tax. 3) see the effect of tax by comparing the initial equilibrium and the new equilibrium. The equilibrium price of ice cream falls from $3 to $2.80, and the equilibrium quantity falls from 100 to 90 cones. The tax on ice cream reduces the size of the ice cream market. Buyers and sellers share the burden of the tax. Sellers get a lower price for their product; buyers pay a lower market price to sellers than they did previously, but the effective price (including the tax buyers have to pay) rises from $3 to $3.30

Price floor

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

When the good is taxed, the side of the market with fewer good alternatives is

Less willing to leave the market and, therefore, bears more of the burden of the tax.

Taxes discourage

Market activity ; when good is taxed, quantity of good sold is smaller in new equilibrium

The equilibrium price is above the price ceiling,

The ceiling is a binding constraint on the market. The forces of S & D tend to move the price toward the equilibrium price, but when the market price hits the ceiling, it cannot, by law, rise any further. Thus, the market price equals the price ceiling. At this price, the quantity demanded exceeds the quantity supplied. Because of this excess demand, some people who want to buy at the going price are unable to do so. In other words, there is a shortage.

When demand is more elastic than supply

The incidence of the tax falls more heavily on producers than consumers. Sellers are not very responsive to changes in the price (so the supply curve is steeper), whereas buyers are very responsive (so the demand curve is flatter). When a tax is imposed, the price paid by buyers does not rise by much, but the price received by sellers falls substantially. Thus, sellers bear most of the burden of the tax.

The equilibrium price is below the floor,

The price floor is a binding constraint on the market. The forces of S & D tend to move the price toward the equilibrium price, but when the market price hits the floor, it can fall no further. The market price equals the price floor. At this floor, the quantity supplied exceeds the quantity demanded. Because of this excess supply, some people who are sellers are unable to sell at the going price. Thus, a binding price floor causes a surplus.

The equilibrium price is above the floor,

The price floor is not binding. Market forces naturally move the economy to the equilibrium, and the price floor has no effect.

When the government imposes a binding price ceiling on a competitive market,

a shortage of the good arises, and sellers must ration the scarce goods among the large number of potential buyers

When the government imposes a binding price floor, it causes

a surplus of the good to develop

A small elasticity of demand means that

buyers do not have good alternatives to consuming this particular good

Taxes levied on buyers and sellers are

equivalent. In both cases, the tax places a arcane between the price that buyers pay and the price that sellers receive. The wedge between the buyers price and the sellers price is the same, regardless of whether the tax is levied on buyers or sellers. In either case, the wedge shifts the relative position of the supply and demand curves. In the new equilibrium, buyers and sellers share the burden of the tax. The only difference between a tax levied on sellers and a tax levied on buyers is who sends the money to the government.

A tax burden falls more heavily on the side of the market that

less elastic (more inelastic)

A small elasticity of supply means that

sellers do not have good alternatives to producing this particular good

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

supply is elastic, and demand is inelastic.

Tax incidence

the actual division of the burden of a tax between buyers and sellers in a market

Buyers and sellers share

the burden of taxes. In the new equilibrium, buyers pay more for the good, and sellers receive less

Which of the following would increase quantity supplied, decrease quantity demanded, and increase the price that consumers pay?

the imposition of a binding price floor

When supply is more elastic than demand

the incidence of the tax falls more heavily on consumers than on producers Sellers are very responsive to changes in the price of the good (so the supply curve is relatively flat), whereas buyers are not very responsive (so the demand curve is relatively steep). When a tax is imposed, the price received by sellers does not fall by much, so sellers bear only a small burden. By contrast, the price paid by buyers rises substantially indicating buyers bear most of the burden of the tax.

The economy is governed by two kinds of laws:

the laws of supply and demand and the laws enacted by governments

The price that balances S & D is below the ceiling,

the price is not binding. Market forces naturally move the economy to the equilibrium, and the price ceiling has no effect on the price or the quantity sold