Government Actions in Markets

Question 1

What is a price ceiling?

Answer 1

A regulation that makes it illegal to charge a price higher than a specified level

Question 2

What determines the effect of a price ceiling?

Answer 2

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

Question 3

How do price ceilings work in reality?

Answer 3

A rent ceiling set below the equilibrium price creates a housing shortage, increases search activity and a black market

Question 4

How do price ceilings create a housing shortage when rent is below the equilibrium level?

Answer 4

The quantity demanded exceeds the quantity of housing supplied = shortage, this must be allocated among demanders and occurs through increased search activity

Question 5

What is search activity?

Answer 5

The time spent looking for someone with whom to to business, there is a lot of search activity in the housing market

Question 6

Why is it bad that search activity increases as a result of a housing shortage?

Answer 6

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

Question 7

How does a rent ceiling cause a black market to emerge?

Answer 7

Landlords use methods to increase their rent such as “key money” where tenants pay large fees for new locks

Question 8

How does the enforcement of a rent ceiling affect the black market?

Answer 8

• Loose enforcement = black market close to unregulated rent

- Strict enforcement - rent is equal to the maximum price a renter is willing to pay

Question 9

Why are rent ceilings inefficient?

Answer 9

• Underproduction of housing services
• MSB exceeds MSC and deadweight loss shrinks the consumer and producer surplus
• Loss from search activity

Question 10

Are rent ceilings fair?

Answer 10

• 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

Question 11

What are some possible mechanisms to allocate scarce housing?

Answer 11

• 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

Question 12

What happens when rent adjustments are blocked?

Answer 12

Other methods of allocating scarce housing resources operate that do not produce a fair outcome

Question 13

What is a price floor?

Answer 13

A government regulation that makes it illegal to charge a price lower than a specified level

Question 14

What effect does a price floor above the equilibrium level have?

Answer 14

Powerful effects on a market as the PF attempts to prevent the price from regulating the Qs and the Qd

Question 15

How does a minimum wage (price floor) effect unemployment?

Answer 15

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

Question 16

How is the minimum wage unfair in terms of result?

Answer 16

• 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

Question 17

How does the minimum wage block voluntary exchange making it unfair?

Answer 17

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

Question 18

How are minimum wages inefficient?

Answer 18

• Results in unemployment and increased job search

- MSB exceeds MSC and deadweight loss shrinks the firm’s surplus and the worker’s surplus

Question 19

How do taxes affect prices?

Answer 19

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

Question 20

What does a tax on sellers do to the supply curve?

Answer 20

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

Question 21

Is it possible to share the burden of tax equally?

Answer 21

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

Question 22

What is an example of a tax imposed equally on buyers and sellers?

Answer 22

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

Question 23

How does elasticity determine whether buyers or sellers pay the tax?

Answer 23

Perfectly inelastic demand = buyers pay

Perfectly elastic demand = sellers pay

Question 24

Why do buyers inherit the tax burden for perfectly inelastic demand?

Answer 24

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

Question 25

Why do sellers inherit the tax burden for perfectly elastic demand?

Answer 25

Consumers will not buy the product if the price rises due to tax so sellers pay the entire tax

Question 26

How does the division of tax between buyers and sellers depend on the elasticity of supply?

Answer 26

Perfectly inelastic supply = sellers pay

Perfectly elastic supply = buyers pay

Question 27

Why do suppliers pay the tax when supply is perfectly inelastic?

Answer 27

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

Question 28

Why does perfectly elastic supply mean buyers pay the entire tax?

Answer 28

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

Question 29

How do taxes result in inefficient underproduction?

Answer 29

It decreases the Qs, raises the buyers price and lowers in the income the seller receives

Question 30

How does a tax create deadweight loss?

Answer 30

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

Question 31

Which two conflicting principles are applied to a tax system concerning fairness?

Answer 31

• The benefits principle

- The ability to pay principle

Question 32

What is the benefits principle in terms of tax?

Answer 32

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

Question 33

What is the ability to pay principle in terms of tax?

Answer 33

That people should pay tax according to how easily they can bear the burden of the tax