4: Market and Government Policies

Question 1

2 Price controls

Answer 1

1. Price Ceiling

2. Price Floor

Question 2

Price Ceiling

Answer 2

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

Question 3

Price Floor

Answer 3

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

Question 4

2 possible outcomes of price ceiling

Answer 4

1. If the ceiling is above the equilibrium price (not binding)  No effect
2. If the ceiling is below the equilibrium price (binding)  Shortage and non-price rationing (long lines and queuing, discrimination by sellers)

Question 5

Binding vs non-binding

Answer 5

Binding = lead to surplus or shortage (has an effect)
Non-binding = doesn’t have an effect

Question 6

Two possible outcomes of price floor

Answer 6

1. If the floor is below the equilibrium price (not binding)  No effect
2. If the floor is above the equilibrium (binding)  Surplus and non-price rationing (discrimination by buyers)

Question 7

Impact of taxes

Answer 7

Taxes result in a change in market equilibrium

In the new equilibrium, quantity traded is lower regardless whom the tax is levied on
- Taxes discourage market activity, however they are necessary to raise revenue to finance some projects and services

Buyers and sellers share the tax burden regardless of whom the tax is levied on

Question 8

Tax Incidence GENERAL RULE

Answer 8

the burden of tax falls more heavily on the side of the market that is less elastic.

Question 9

Subsidy

Answer 9

A subsidy is a payment from the government to consumers or sellers, for each unit of a good that is bought or sold  subsidies can be regarded as negative taxes.

Question 10

Effect of a subsidy to sellers

Answer 10

 The supply curve will shift downward (to the right) by the amount of the subsidy
 Like a tax, the subsidy creates a wedge between the price buyers pay and the price sellers receive

• Although the subsidy is paid to sellers, the benefits are enjoyed by both buyers and sellers

Question 11

Impact of subsidies

Answer 11

• Quantity traded in equilibrium is higher

• Subsidies encourage market activity
• However, they are costly

• Buyers pay less and sellers receive more
- Buyers and sellers share the benefit regardless of who receives the subsidy