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Chapter 6 and 8 - Price Control and Taxes.docx

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Hannah Holmes

Chapter 6/8 – Price Controls and Taxes Price Controls - Enacted when policy makers believe the market price is unfair to buyers or sellers. - The government will freeze prices at a predetermined level that they feel will make members of society better off Price Ceiling - A legal maximum on the price at which a good can be sold. - It is only effective if set below equilibrium price, where it will lead to a shortage. Above equilibrium price, it will have no effect (not binding). Example: Rent Control The government’s goal is to help the poor by making housing more affordable. It sets a maximum rent for housing that is below equilibrium price. In the short run, the number of apartments is fixed, so Supply of housing is inelastic. Demand for housing in the short run is relatively inelastic. In the long run, low rents can mean that landlords may convert to condos, get out of the rental business, and/or won’t maintain existing apartments, so supply is inelastic. Low rents encourage people to look for housing, so Demand is elastic. In the long run, the housing shortage is large. Where rent controls exist, landlord must resort to: - Waiting lists - Discrimination - Bribes - Converting apartments to condominiums. Numerical Example: The equations for demand and supply for 1-bedroom apartments in Glanbrook are: Qd = 1700 – 2P Qs = 2P – 900 Therefore P = 650 at equilibrium. Qd = 1700 – 2(650) = 400 = Qs = Q* What if the province imposes a rent of $500? If P = 500, Qd = 1700 – 2(500) = 700 Qs= 2(500) – 900 = 100 Shortage = Qd – Qs = 600 Price Ceilings Lead To - Shortages that worsen over time - Inefficient allocation to consumers o People who want the good badly may not get it while those who care less do - Wasted resources o A lot of time can be spent trying to find an apartment - Inefficiently low quality o No incentive for landlords to keep up apartments if they have to rent cheaply. Black Market Example: “I’ll rent you an apartment if you slip me an extra $500 a month under the table.”
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