Economics 101, Introduction to Economics, Ch. 6 Notes

If a price ceiling is not binding...

(Applicable if price ceiling is above equilibrium price) : market forces naturally move the economy to the equilibrium, and the price ceiling has no effect on the price or the quantity sold.

If a price ceiling is a binding constraint...

(Applicable if price ceiling is below equilibrium price) : when the market price hits the ceiling, it cannot, by law, rise any further. Therefore, there is a shortage. The supply and demand do not change, just the amount available to consumers.

Effects of binding price ceilings:

1. Discrimination according to seller bias (inefficient). 2. Long lines (inefficient).

Two lessons of tax on sellers

1. Taxes discourage market activity. When a good is taxed, the quantity of good sold is smaller in the new equilibrium. 2. Buyers and sellers share the burden of taxes. In the new equilibrium, buyers pay more for the good, and sellers receive less.

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.

If supply of a resource falls and the price ceiling of a resource is binding...

A shortage occurs. The difference between the quantity demand and quantity supplied measures the resource shortage.

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.

General lesson about how the burden of a tax is divided

A tax burden falls more heavily on the side of the market that is less elastic. When a good is taxed, the side of the market with fewer good alternatives is less willing to leave the market and must, therefore, bear more of the burden of the tax.

Effect of the luxury tax

A tax on a luxury good like yachts places a burden largely on the firms and workers who build yachts because they end up getting a significantly lower price for their product. The burden of the luxury tax falls more on the middle class than on the rich.

Effect of a tax on sellers

A tax on sellers shifts the supply curve upward by the size of the tax. Equilibrium quantity decreases. Price that buyers pay rises. The price that sellers receive falls. Both buyers and sellers share the burden of the tax. The tax does make sellers worse off overall.

Long-term effects of rent control

Because the supply and demand curves for apartments are more elastic, rent control causes a large shortage. This is caused by landlords responding to low rents by not building new apartments and by failing to maintain existing ones. Quantity of apartments demanded rises substantially in long term thanks to low rent. Therefore, large shorting of housing.

NOTE: The impact of the minimum wage depends on the skills and the experience of the worker.

Highly experienced and skilled workers are not affected because their equilibrium wages are well above the minimum. For these workers, minimum wage is not binding.

Price floor that is binding

If price floor is above the equilibrium price, the demand for a certain quantity of resources is lower than the quantity supplied. Therefore, there is a surplus.

Effect of tax burden on inelastic supply, elastic demand

In this scenario, the incidence of the tax falls more heavily on producers than on consumers. Price received by sellers falls substantially, while the price paid by buyers rises only slightly. Sellers bear most of the burden of the tax.

Effect of tax burden on elastic supply, inelastic demand

In this scenario, the price received by sellers falls only slightly, while the price paid by buyers raises substantially. Buyers bear most of the burden of the tax. When supply is more elastic than demand, the incidence of the tax falls more heavily on consumers than on producers.

An increase in a price ceiling will...

Increase quantity supplied, decrease quantity demanded, reduce the shortage.

A labor market with a binding minimum wage

Minimum wage sets the price floor. Therefore, the quantity supplied exceeds the quantity demanded. A labor surplus is created, a.k.a. unemployment.

Effect of a payroll tax

Payroll tax places a wedge between the wage that workers receive and the wage that firms pay. Workers and firms share the tax burden. Division of tax burden between workers does not depend on whether government levies the tax on workers, levies tax on firms, divides tax equally between two groups. However, most labor economists believe that the supply of labor is much less elastic than the demand. Workers, rather than firms, bear most of the burden. Distribution of payroll tax is in essence not a 50/50 split.

Price floor that is not binding

Since price floor is below equilibrium price, the price floor has no effect.

Payroll tax

Tax on the wages that firms pay their workers.

Implications of taxes levied on buyers and sellers

Taxes levied on sellers and taxes levied on buyers are equivalent. Once the market reaches its new equilibrium, buyers and sellers share the burden, regardless of how the tax is levied. Wedge between buyers' price and sellers' price is the same.

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.

Tax incidence

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

The minimum wage has its greatest impact on...

The market for teenage labor. The minimum wage is binding more often for teenagers than for other members of the labor force.

Short-term effects of rent control

The price ceiling imposed by a rent-control law causes only a small shortage of housing. This is because the supply and demand curves for apartments are inelastic.

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.

When the government levies a tax on a good, the equilibrium quantity of the good falls.

Therefore, the tax on a market shrinks the size of the market.

How taxes on sellers affect market outcomes

Three steps: (1) We decide whether the law affects the supply curve or demand curve. (2) We decide which way the curve shifts. (3) We examine how the shift affects the equilibrium price and quantity.

A free labor market without minimum wage

Wage adjusts to balance labor supply and labor demand. Workers determine the supply of labor, and firms determine the demand.

Effect of a tax on buyers

When a tax of "x" price is levied on buyers, the demand curve shifts down by "x" price from D1 (Demand 1) to D2 (Demand 2). Equilibrium quantity decreases. Price that sellers receive falls as well. Price that buyers pay rises. Buyers and sellers share the burden of the tax. A tax on buyers shifts the demand curve downward by the size of the tax.