Why does the government need price control policies? Two price control policies: price ceiling and price floor. Impacts of government price control policies on market outcomes. Lessons that we can learn from government price policies. What we will learn in this class
Why does the government want to regulate market prices? • A competitive market free of government regulations is efficient when it is at equilibrium. • However, some suppliers or demanders may not be satisfied with the market equilibriums. • As a result of such dissatisfaction, they may try to lobby the government to impose price control policies.
What kind of price control policies the government may adopt? • Price ceiling (if demanders win): is a legally determined maximum price that sellers may charge. • Price floor (if suppliers win): is a legally determined minimum price that sellers may receive.
Impacts of government price control policies on market • Price ceiling: Example: Rent control • Price floor: Example: Minimum wage
Price Ceiling: Rent Control in New York City • It dates back to the housing shortage following World War II and generally applies to buildings constructed before 1947 in New York City. • Rent control is intended to protect tenants in privately-owned buildings from illegal rent increases.
P S Rental price of apts $800 D Q 300 Quantity of apartments Price Ceiling: Rent ControlThe Market for Apartments without Price Ceiling Equilibrium without price controls
P S Price ceiling $500 shortage D Q 400 250 Price Ceiling: Rent ControlThe Market for Apartments with Price Ceiling that is binding The eq’m price ($800) is above the ceiling and therefore illegal. The ceiling is a binding constrainton the price, and causesa shortage. $800
Effects of A Binding Rent Control • A binding rent control creates • a shortage of apartments: long waiting lists. • Non-price rationing: more low income families may not be able to find an apartment to rent. • It also encourages Black Market.
Summary: market outcomes of government price ceiling policy • Price ceiling reduces market efficiency (shortage). • Non-price rationing. • In contrast, a competitive equilibrium market without price controls is more efficient.
Price Floor: Minimum Wage • Minimum wage in Pennsylvania has risen to $6.25 starting Jan. 1, 2007 and will continue to increase to $7.15 on July 1, 2007. • It has been designed to protect those with low skills, low education and teenager workers.
W S Wage paid to unskilled workers $4 D L 500 Quantity of unskilled workers Price Floor: Minimum WageUnskilled labor market without minimum wage Eq’m w/o price controls
labor surplus W S Price floor $7.15 $6 D L 400 550 Price Floor: Minimum WageUnskilled labor market with a binding minimum wage The equilibrium wage ($6) is below the floor and therefore illegal. The floor is a binding constrainton the wage, and causes a surplus(i.e., unemployment).
Market Outcomes of A Binding Minimum Wage • A binding minimum wage creates • a surplus of unskilled workers. (more unemployment). • non-price rationing: employers may discriminate certain types of job applicants. • more labor supply from teenagers: people in need may end up losing jobs.
Summary: Market outcomes of government price floor policy • Price floor reduces market efficiency (surplus). • Non-price rationing. • In contrast, the competitive equilibrium market without price floor is more efficient.
Lessons that we can learn from government price control policies • Price plays a very crucial role in our economy. • Controlling price may reduce market efficiency and may miss the policy intentions. • Alternative government policies.
Content • Tax • Tax on buyer side • Tax on seller side • Applications
Importance of tax • Tax incidence: distribution of tax • When a new tax is imposed, who will pay it? • What’s the market outcomes?
When A New Tax Is Imposed on Buyers • Tax on Cigarettes
Step one • Tax shift demand curve? • Step two • How demand curve shifts? • Step three • Compare two equilibriums
Implications If the government levies a tax on buyers • Taxes reduce quantity of good sold • Buyers and sellers share the burden of taxes • Elasticity and tax on buyers
When A New Tax Is Imposed on Sellers • Taxes on oil companies • BP took in 250 billion revenue last year
Step one • A tax will shift supply curve? • Step two • How? • Step three • Compare two equilibriums
Implications If the government levies a new tax on sellers • A new tax will discourage market activities, reducing quantity of goods sold. • Sellers and buyers share the burden of taxes • Elasticity and tax on sellers