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Lecture

Chapter 6- Government Actions in Markets

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Department
Economics
Course
ECON 101
Professor
Emanuel Carvalho
Semester
Winter

Description
Chapter 6: Government Actions in Markets A Housing Market with a Rent Ceiling  Price ceiling (price cap): A regulation that makes it illegal to charge a price higher than a specific level  A price ceiling set above the equilibrium price has no effect  Reason is that the price ceiling does noty constrain the market forces  The force of the law and the market forces are not in conflict  A price ceiling below the equilibrium price has powerful effects on a market  Reason is that the price ceiling attempts to prevent the price from regulating the quantities demanded and supplied  The force of the law and the market forces are in conflict  Rent ceiling: When a price ceiling is applied to a housing market  A rent ceiling set below the equilibrium rent creates o A housing shortage o Increased search activity o A black market A Housing Shortage  At a rent set below the equilibrium rent, the quantity of housing demanded exceeds the quantity of housing supplied- there is a shortage  Therefore, if a rent ceiling is set below the equilibrium rent, there will be a shortage of housing Increased Search Activity  Search activity: The time spent looking for someone with whom to do business  The opportunity cost of a good is equal not only to its price but also to the value of the search time spent finding the good  Opportunity cost of housing is equal to the rent (regulated price) plus the time and other resources spent searching for the restricted quantity available  A rent ceiling controls only the rent portion fo the cost of housing. The cost of increased search activity might end up making the full cost of housing higher than it would be without a rent ceiling A Black Market  A rent ceiling also encourages illegal trading in a black market: an illegal market in which the equilibrium price exceeds the price ceiling  Occur in rent-controlled housing and many other markets  The level of a black market rent depends on how tightly the rent ceiling is enforced o With loose enforcement, the black market rent is close to the unregulated rent o With strict enforcement, the black market rent is equal to the maximum price that a renter is willing to pay Pg.131 Inefficiency of a Rent Ceiling  A rent ceiling set below the equilibrium rent results in an inefficient underproduction of housing services  The marginal social benefit from housing exceeds its marginal social cost and a deadweight loss shrinks the producer surplus and consumer surplus Are Rent Ceilings Fair?  According to the fair rules view, anything that blocks voluntary exchange is unfair, so rent ceilings are unfair  But according to the fair result view, a fair outcome is one that benefits the less well off  So according to this view, the fairest outcome is the one that allocates scarce housing to the poorest people  When the rent is not permitted to allocate scarce housing, some possible mechanisms are: 1. A lottery 2. First come, first-served 3. Discrimination A Labour Market with a Minimum Wage  Price floor: A regulation that makes it illegal to trade at a price lower than a specified level  A price floor set below the equilibrium price has no effect  Reason: price floor does not constrain the market forces  A price floor above the equilibrium price has powerful effects on a market  Reason: Attempts to prevent the price from regulating the quantities demanded and supplied  Minimum wage: When a price floor is applied to a labour market  A minimum wage imposed at a level that is above the equilibrium wage creates unemployment Minimum Wage Brings Unemployment  At a wage rate above the equilibrium wage, the quantity of labour supplied exceeds the quantity of labour demanded- there is a surplus of labour  So when a minimum wage is set above the equilibrium wage, there is a surplus of labour  The demand for labour determines the level of employment, and the surplus of labour is unemployed Inefficiency of a Minimum Wage  Supply curve measures the marginal social cost of labour to workers  Demand curve measures the marginal social benefit from labour value of the goods and services produced Is the Minimum Wage Fair?  Minimum wage is not fair  Only those people who have jobs and keep them benefit from the minimum wage  The unemployed end up worse off than they would be with no minimum wage  Blocks voluntary exchange Taxes Tax Incidence  Tax Incidence: the division of the burden of a tax between buyers and sellers  If the price paid by buyers rise by the full amount of the tax, then the burden of the tax falls entirely on buyers- the buyers pay the tax  If the price paid by buyers rises by a lesser amount than the tax, then the burden of the tax falls partly on buyers doesn’t change at all burden of the tax falls entirely on sellers A Tax on Sellers  A tax on sellers is like an increase in cost, so it decreases supply A Tax on Buyers  A tax in buyers lowers the amount they are willing to pay sellers, so it decreases demand and shifts the demand curve leftward Equivalence of Tax on Buyers and Sellers Can We Share the Burden Equally?  No; tax have same effect regardless of whether it is imposed on sellers or buyers  When a transaction is taxed, there are two prices: the price paid by buyers, which includes the tax; and the price received by sellers, which excludes the tax  Buyers respond to the price that includes the tax and sellers respond to the price that excludes the tax The Employment Insurance Tax  Example of a tax that the federal government imposes on both buyers of labour (employers) and sellers of labour (employees)  The market for labour decides how the burden of the Employment Insurance tax is divided between firms and workers Tax Incidence and Elasticity of Demand  The division of the tax between buyers and sellers depends in part on the elasticity of demand. There are two extreme cases: 1. Perfectly inelastic demand-buyers pay 2. Perfectly elastic demand-sellers pay Perfectly Inelastic Demand  Buyers pay the entire tax Perfectly Elastic Demand  Sellers pay the entire tax  In the usual case, demand is neither perfectly inelastic nor perfectly elastic and the tax is split between buyers and sellers  But the division depends on the elasticity on demand: The more inelastic demand, the larger the amount of the tax is paid by buyers Tax Incidence and Elasticity of Supply  The division of the tax between buyers and sellers also depends, in part, on the elasticity of supply There are two extreme cases: 1. Perfectly inelastic supply-sellers pay 2. Perfectly elastic supply- buyers pay Perfectly Inelastic Supply  If an item is taxed, the supply curve does not change because the good still produces the same quantity in a period, even if the price they receive falls  However, buyers are only willing to buy the good at the same price; so the sellers say the entire tax Perfectly Elastic Supply  The tax increases the price buyers pay by the full amount of the tax and decreases the quantity sold  Buyers pay the entire tax  When supply is perfectly inelastic, sellers pay the entire tax; and when supply is perfectly elastic, buyers pay the entire tax  In the usual case, supply is neither perfectly inelastic nor perfectly elastic and the tax is split between buyers and sellers  The more elastic the supply, the larger is the amount of the tax paid by buyer Taxes and Efficiency  A tax drives a wedge between the buying price and the selling price and results in inefficient underproduction  The price buyers pay is also the buyers’ willingness to pay, which measures marginal social benefit  The price sellers receive is also the sellers’ minimum supply-price, which equals marginal social cost  A tax makes marginal social benefit exceed marginal social cost,
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