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Chapter 6

ECON 1000 Chapter Notes - Chapter 6: Price Ceiling, Tax Incidence, Working Poor

Course Code
ECON 1000
Troy Joseph

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ECON 1000
Controls on prices
If ice cream is sold in a competitive market free of government regulation, the price of ice
cream adjusts to balance supply and demand: at the equilibrium proce, the quantity of ice
cream that buyers want to buy exactly equals the quantity that sellers want to sell. To be
concrete, lets suppose that the equilibrium price is $3 dollars per cone.
The buyers may be thinking this is too much and some ice cream group might be lobbying that
this price is too low.
If the ice cream eaters are successful in their lobbying, the government imporses a legal
maximum on the price at which ice cream can be sold. Because the price is not allowed to rise
above this level, the legislated maximum is called a price ceiling. By contrast, if the makers are
successful, the government imposes a legal minimum on the price. Because the price cannot fall
below this level, the legislated minimum is called a price floor.
How Price Ceilings affect market outcomes
2 outcomes are possible.
Let’s sa the goeret iposes a prie eilig at $4 per oe. I this ase, eause the proe
that balances supply and demand ($3) is below the ceiling, the price ceiling is not binding.
Market forces naturally move the economy to the equilibrium, and the price ceiling has no
effect on the price of the quantity sold.
Another possibility would be that the government imposes a price ceiling of $2 per cone.
Because the equilibrium price of $3 is above the price ceiling, the ceiling is a binding constraint
on the market. The forces of supply and demand tend to move the price toward the equilibrium
price, but when the market price hits the ceiling, it can rise no further. Thus, the market price
equals the price ceiling. At this price,m the quantity of ice cream demanded exceeds the
quantity supplied.
In response to the shortage, some mechanism for rationing ice cream will naturally develop.
The mechanism could be long lines: Buyers who are willing to arrive early and wait in line get a
cone, while those unwilling to wait do not. Alternatively, sellers could ration ice cream cones
according to their own personal biases, selling them only to friends, relatives, or members of
their own racial or ethinic group. This shows that not all buyers will benefit from this.
When the government imposes a binding price ceiling on a competitive market, a shortage of
the good arises, and sellers must ration the scarce goods among the large number of potential
buyers. The rationing mechanisms that develop under price ceiling are rarely desirable. Long
lines are inefficient because they waste time. Discrimination is both inefficient and unfair.
How price floors affect market outcomes
Again, 2 outcomes are possible. If the government imposes a price floor or $2 per cone when
the equilibrium price is $3, the price floor is not binding. Market forces naturally move the
economy to the equilibrium, and the price floor has no effect.
Lets say the price floor is $4. The market price equals the price floor. At this floor, the quantity
of ice cream supplied exceeds the quantity demanded. Thus, a binding price floor causes a
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