Government Intervention Flashcards
What is a price ceiling?
Legal maximum on the price at which a good can be sold
e.g. rent control laws
What is a price floor?
Legal minimum on the price at which a good can be sold
e.g. minimum wage laws
What is a binding price ceiling?
Set below equilibrium price, market price must be the price ceiling (shortage)
What happens when the gov imposes a binding price ceiling?
Shortage- quantity demanded exceeds quantity supplied
Rationing mechanisms are rarely desirable
Long lines waste buyers’ time
bias of sellers, inefficient and unfair
What is a non-binding price ceiling?
Set above equilib price, no effect on price or quantity sold
What is the rationing mechanism?
A system that controls the distribution of limited resources during a shortage or crisis
What is a binding price floor?
Set above the equilibrium price, some sellers unable to sell what they want (surplus)
What is a non-binding price floor?
Set below the equilibrium price, no effect on price or quantity sold
What happens when the gov imposes a binding price floor?
Surplus, quantity supplied exceeds quantity demanded
Sellers who appeal to the buyers’ personal biases may be better able to sell their goods than those who do not
When is the price the rationing mechanism?
In a free market
sellers may not be happy about how much they are paid at the equilibrium price, but they can sell all they want
What are taxes?
Gov use taxes to raise revenue for public projects
Tax can be imposed on buyers (demand) or sellers (supply)
What is tax incidence?
The manner in which the burden of a tax is shared among participants in a market
How to calculate tax incidence
Ignore the shift first
Make one thing p
and the other thing p+tax
Creates a new equilibrium with different price paid and price received
Shift the curve of the group the tax is being imposed on (buyers or sellers) to find new equilibrium quantity
What does a tax do?
Inserts a wedge between price that buyers pay and price that sellers receive
Buyers and sellers share the tax burden in the new equilibrium
What is a payroll tax?
Places a wedge between what firms pay and what workers receive
Where does the tax burden fall more heavily on?
The side of the market that is LESS elastic.
Why?
Elasticity meausres the willingness of buyers and sellers to leave the market when conditions worsen
Small elasticity of demand = buyers do not have good alternatives to consuming the particular good
Small elasticity of supply: sellers do not have good alternatives to producing this particular good
Therefore the side of the market less willing to leave the market bears more of the burden of the tax
What determines whether the deadweight loss from a tax is large or small?
Price elastics of supply and demand
If more elastic, larger deadweight loss
Why does a tax have a deadweight loss?
It induces buyers and sellers to change their behavior.
Tax- raises price paid by buyers, they consume less
Tax- lowers price received by sellers, they produce less
