Week 6: Government Actions in Markets Flashcards
What is a price ceiling?
A government regulation that establishes a legal maximum price for a good or service
What is a rent ceiling?
A price ceiling applied to the housing market
What are the effects of a price ceiling if it is set above equilibrium price?
It’s a non-binding constraint so it’s ineffective.
What are the effects of a price ceiling if it is set below equilibrium price?
It’s a binding constraint that results in a shortage, increased search activity, and black market trading.
What is search activity?
It’s the time, effort, and resources spent looking for someone to buy from.
What is a black market?
An illegal market in which the equilibrium price exceeds the price ceiling (trading illegally at a price above the ceiling).
How are scarce housing resources allocated when a rent ceiling is in place?
Methods other than the market price (e.g. lottery, first-come, first-served, discrimination)
Why does a rent ceiling create an inefficient and unfair outcome in the housing market?
Inefficient: A rent ceiling set below equilibrium rent results in inefficient underproduction (shortage), so the marginal social benefit exceeds the marginal social cost. This results in a deadweight loss and shrinks the consumer and producer surplus.
Unfair: Housing isn’t allocated to the poor.
What is a price floor?
A government regulation that establishes a legal minimum price for a good or service
What is a minimum wage?
A price floor applied to the labour market
What are the effects if a price floor is set above the equilibrium price?
It’s a binding constraint that results in a surplus (unemployment) and increased search activity.
How are scare jobs allocated when a minimum wage is in place?
Other mechanisms other than the wage rate are used such as discrimination.
Why does a minimum wage create an inefficient allocation of labour resources?
At the quantity of labour employed, firm’s marginal social benefit exceeds worker’s marginal social cost and a deadweight loss shrinks the consumer surplus and producer surplus.
Why is a minimum wage unfair?
Unfair result: Only those who have and keep their jobs benefit from the minimum wage. Others are worse off.
Unfair rules: There is no voluntary exchange.
What is the equation for tax (T) in dollars per unit?
Difference between what consumers pay and what producers receive
T= Pc - Pp
What is a consumer price?
Total amount paid by consumers including any tax paid
What is a producer price?
Total amount received by producers net of any tax paid
How does the elasticity of demand influence the incidence of a tax, the tax revenue, and the deadweight loss?
a) The more elastic the demand, the smaller the amount of tax paid by buyers, and the greater the amount of tax paid by sellers.
b) The more elastic the demand, the smaller the government tax revenue.
c) The more elastic the demand, the greater is the deadweight loss.
How does the elasticity of supply influence the incidence of a tax, quantity bought, tax revenue, and deadweight loss?
a) The more elastic the supply, the smaller the amount of tax paid by sellers, and the greater the amount of tax paid by buyers.
b) The more elastic the supply, the greater the decrease in the quantity bought.
c) The more elastic the supply, the smaller the government tax revenue.
d) The more elastic the supply, the greater is the deadweight loss.
Why is a tax inefficient?
Tax drives a wedge between what consumers pay and what producers receive, resulting in inefficient underproduction. Marginal social benefit exceeds marginal social costs, consumer and producers surplus shrink, and a deadweight loss is created.
Why would a tax be efficient?
Tax is efficient when demand and supply are perfectly inelastic. It does not create a deadweight loss and the quantities bought and sold remain the same.
What are the two principles of fairness that are applied to tax systems?
a) Benefit principle- people should pay taxes equal to the benefits they receive
b) Ability-to-pay principle- people should pay taxes according to how easily they can bear the burden of the tax
What is the effect of a tax levied on producers?
It decreases market supply. Supply curve shifts leftward by the amount of the tax at every quantity.
What is the effect of a tax levied on consumers?
It decreases market demand. Demand curve shifts leftward by the amount of the tax at every quantity.
