Government Actions in Markets Flashcards
What is a price ceiling?
A regulation that makes it illegal to charge a price higher than a specified level
What determines the effect of a price ceiling?
Whether the price is set above or below the equilibrium price - above has no effect but below prevent price from regulating the QS and Qd
How do price ceilings work in reality?
A rent ceiling set below the equilibrium price creates a housing shortage, increases search activity and a black market
How do price ceilings create a housing shortage when rent is below the equilibrium level?
The quantity demanded exceeds the quantity of housing supplied = shortage, this must be allocated among demanders and occurs through increased search activity
What is search activity?
The time spent looking for someone with whom to to business, there is a lot of search activity in the housing market
Why is it bad that search activity increases as a result of a housing shortage?
The OC of the house is equal to its price AND the value of time spent finding the hours, it is costly and makes the full cost of housing higher than without the rent ceiling
How does a rent ceiling cause a black market to emerge?
Landlords use methods to increase their rent such as “key money” where tenants pay large fees for new locks
How does the enforcement of a rent ceiling affect the black market?
- Loose enforcement = black market close to unregulated rent
- Strict enforcement - rent is equal to the maximum price a renter is willing to pay
Why are rent ceilings inefficient?
- Underproduction of housing services
- MSB exceeds MSC and deadweight loss shrinks the consumer and producer surplus
- Loss from search activity
Are rent ceilings fair?
- Fair rules view - anything that blocks voluntary exchange is unfair so YES
- Fair result view - the poor must be benefit, this isn’t the case
What are some possible mechanisms to allocate scarce housing?
- Lottery allocates to those who are lucky, not poor
- First come first serve allocates to those who get their names on a list first, not who are poor
- Discrimination allocates based on the views and self interest of the owner
What happens when rent adjustments are blocked?
Other methods of allocating scarce housing resources operate that do not produce a fair outcome
What is a price floor?
A government regulation that makes it illegal to charge a price lower than a specified level
What effect does a price floor above the equilibrium level have?
Powerful effects on a market as the PF attempts to prevent the price from regulating the Qs and the Qd
How does a minimum wage (price floor) effect unemployment?
When a minimum wage is set above the equilibrium level, there is a surplus of labour, this surplus is unemployed as demand for labour determines employment level
How is the minimum wage unfair in terms of result?
- Only those people who have jobs and keep them benefit from the minimum wage
- Some who search for jobs end up worse off due to increased cost of job search.
- Those who search and find jobs are not always the least well off
How does the minimum wage block voluntary exchange making it unfair?
Firms are willing to hire more labour and people are willing to work more but they are not permitted by the minimum wage law to do so
How are minimum wages inefficient?
- Results in unemployment and increased job search
- MSB exceeds MSC and deadweight loss shrinks the firm’s surplus and the worker’s surplus
How do taxes affect prices?
When the gov imposes a tax on the sale of a good, the price paid by buyers might rise by the full amount or by a lesser amount. If price rises, the burden falls on the buyer, if it rises but by a lesser amount, the burden is shared, if not at all it falls on sellers
What does a tax on sellers do to the supply curve?
It decreases supply like an increase in cost, tax+minimum price that sellers are willing to accept = S2, equilibrium occurs where the new supply curve intersects the demand curve
Is it possible to share the burden of tax equally?
Imposing half the tax on buyers and half on sellers causes buyers to respond to the price that includes tax and sellers to respond to the price that excludes tax
What is an example of a tax imposed equally on buyers and sellers?
Social security tax - the market for labour determines how the burden of SST is divided between firms and workers, depends on the elasticities of demand and supply
How does elasticity determine whether buyers or sellers pay the tax?
Perfectly inelastic demand = buyers pay
Perfectly elastic demand = sellers pay
Why do buyers inherit the tax burden for perfectly inelastic demand?
E.g demand for insulin, buyers won’t not buy insulin if there is a tax because they need insulin, this means buyers take on the burden
Why do sellers inherit the tax burden for perfectly elastic demand?
Consumers will not buy the product if the price rises due to tax so sellers pay the entire tax
How does the division of tax between buyers and sellers depend on the elasticity of supply?
Perfectly inelastic supply = sellers pay
Perfectly elastic supply = buyers pay
Why do suppliers pay the tax when supply is perfectly inelastic?
The supply for bottled water is perfectly elastic as buyers are only willing to pay a specific price for a bottle of water, the Qs does not change as a result of as a result of an increase in tax on water
Why does perfectly elastic supply mean buyers pay the entire tax?
Price increases as a result of the tax, a new equilibrium is determined, the quantity sold has decreased as buyers pay the whole tax and may not want to purchase the good at the new price
How do taxes result in inefficient underproduction?
It decreases the Qs, raises the buyers price and lowers in the income the seller receives
How does a tax create deadweight loss?
MSB exceeds MSC and the producer and consumer surplus shrink creating deadweight loss, part of each surplus goes to the gov in tax revenue and the rest to deadweight loss
Which two conflicting principles are applied to a tax system concerning fairness?
- The benefits principle
- The ability to pay principle
What is the benefits principle in terms of tax?
That people should pay tax equal to the benefits they received from the services provided. Fair because those that benefit the most, pay the most. It justifies fuel taxes to pay for motorways, taxes on alcohol to pay for healthcare etc
What is the ability to pay principle in terms of tax?
That people should pay tax according to how easily they can bear the burden of the tax
