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CONTROLS ON PRICES

CONTROLS ON PRICES. Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Price Ceiling - legal maximum on the price at which a good can be sold. Price Floor - legal minimum on the price at which a good can be sold. . Price Ceiling.

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CONTROLS ON PRICES

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  1. CONTROLS ON PRICES • Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. • Price Ceiling - legal maximum on the price at which a good can be sold. • Price Floor - legal minimum on the price at which a good can be sold.

  2. Price Ceiling legal maximum on the price at which a good can be sold. S $/Q Shortage = Q2 – Q1 P* Max. P D Q/t Q2 Q1

  3. How Price Ceilings Affect Market Outcomes A binding price ceiling creates • shortages because QD > QS. • nonprice rationing • Discrimination • Wasted resources as buyers search for goods • Inefficient distribution of goods among buyers • Illegal market.

  4. How Price Floors Affect Market Outcomes - legal minimum on the price at which a good can be sold. price S min. p Surplus = Q2 – Q1 P* D Q/t Q2 Q1

  5. How Price Floors Affect Market Outcomes A binding price floor causes . . . • a surplus because QS > QD. Examples: The minimum wage, agricultural price supports. • nonprice rationing- floor enhances buyers’ power- • is an alternative mechanism for rationing the good, using discrimination criteria.

  6. Who Pays the Tax? 10 m. packs of cigarettes sell for $2/pk. A tax of $1 per pack is levied. Results: consumption falls by 1m. packs and the price rises to ___? Pd = price that buyers pay (includes the tax). Ps = price that sellers keep (excludes the tax). Without a tax, Pd=Ps. With a tax, Pd - tax = Ps. Pd Q Without tax 2.00 10 With tax = $1/Q 2.80 9

  7. Who Pays the Tax? Pd = price buyers pay. Ps = price sellers keep. Without a tax, Pd=Ps. With a tax, Pd - tax = Ps. Pd Q Without tax 2.00 10 With tax = $1/Q 2.80 9 $/pk. 2.80 S Buyers pay $0.80 2.00 1.80 Sellers pay the other $0.20. D m. pk. per mth. 9 10

  8. Who Pays the Tax? Tax of $4/hr on workers. S + $4 wage S $14 11 10 D 7 Pd – tax = Ps m. hours 35 40

  9. Who Pays the Tax? Tax of $4/hr on employers. wage S 11 10 7 D 6 Pd – tax = Ps D -$4 m. hours 35 40

  10. Who sends the tax to the government does not matter! S+$4 wage S 14 Pd – tax = Ps 11 10 D 7 6 D-$4 m. hours 40 35

  11. Who Pays the tax? Depends on elasticities of S and D, not on who sends the check to the government. Buyers pay most of the tax here. P S P S D Sellers pay most here. D Q Q

  12. Summary • Price controls include price ceilings and price floors. • A price ceiling is a legal maximum on the price of a good or service. An example is rent control. • A price floor is a legal minimum on the price of a good or a service. An example is the minimum wage. • Taxes are used to raise revenue for public purposes. • When the government levies a tax on a good, the equilibrium quantity of the good falls. • A tax on a good places a wedge between the price paid by buyers and the price received by sellers. • The incidence of a tax refers to who bears the burden of a tax. • The incidence of a tax does not depend on whether the tax is levied on buyers or sellers. • The incidence of the tax depends on the price elasticities of supply and demand. • The burden tends to fall on the side of the market that is less elastic.

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