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Lecture 9

ECN 001A Lecture Notes - Lecture 9: Tax Incidence, Price Ceiling, Price Floor

Course Code
ECN 001A

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FEB 13
CH 6 - Supply, Demand, and Government Policies
Government Policies that alter the Private Market Outcome
- Binding or nonbinding price set?
- Binding → surplus or shortage?
- Price controls
- Price ceiling: a legal maximum on the price of a good or service
- Govt says the price cannot go above this limit
- Ex. rent control
- Price floor: a legal minimum on the price of a good or service
- Govt says the price cannot go below this level
- Ex. minimum wage
- Taxes
- The govt can make buyers or sellers pay a specific amount on each unit
- Ex. sales tax on soda
- Whoever has the larger elastic curve will pay less tax
- We will use the supply/demand model to see how each policy affects the market outcome (the price buyers pay, the price sellers
receive, and the eq’m quantity)
How Price Ceilings affect Market Outcomes
- Price ceiling above the eq’m price = non binding: has no effect on the market outcome
- Price ceiling below the eq’m price = binding constraint on the price → causes a shortage
- Ex. Due to new regulations, gas stations that would like to pay better wages in
order to hire more workers are prohibited from doing so.
- **In the long run, supply and demand are more price-elastic → larger shortage
Shortages and Rationing
- With a shortage, sellers must ration the goods among buyers
- Long lines, discrimination according to sellers’ biases, etc.
- Mechanisms are often unfair and inefficient. Goods don’t go to buyers who value
them most highly
- Ex. Rent-control laws
- Most common long-run outcomes (when there is a shortage - excess demand):
- Quality decreases
- Landlords may convert existing apartments to more profitable uses → less units available for renters in the
- Black market
- Renters may make under-the-table payments to secure an apt
- Alternative methods of rationing will emerge bc price is no longer an effective mechanism of rationing apts.
- Ex. screening processes, personal networking connections
- But, when prices are not controlled, the rationing mechanism is efficient and impersonal (fair)
- The goods go to the buyers that value them most highly
How Price Floors affect Market Outcomes
- Price floor above the eq’m price = binding constraint on the wage → causes a surplus
(more people are willing to work)
- Price floor below the eq’m price = non binding: has no effect on the market outcome
- Ex. Minimum wage
- Min. wage laws don’t affect highly skilled workers, however they do affect teen
- Studies: 10% increase in the min. wage
raises teen unemployment by 1-3%
Ex. The market for hotel rooms (eq’m is at $100, 100 rooms)
- Effects of $90 price ceiling
- Shortage
- Effects of $90 price floor
- No effect
- Effects of $120 price floor
- Surplus
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