Chapter 6 ECON 2000.docx

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23 Apr 2012
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Chapter 6 lecture 9
Governments intervene in markets
Usually based on an equity principle
Rent controls affordability
People with low incomes
Minimum wages protect those at the bottom of the equality ladder
A price ceiling set above equilibrium price has no effect
Unregulated housing market
Shortage rent rises
Quantity supplied of houses increases in the short run because suppliers try to profit on
the higher rent prices and the supply curve of houses shifts back to equilibrium.
A rent ceiling (price ceiling) placed below equilibrium creates:
House shortages, increased search activity and a black market
Regulated housing market
Rent ceiling (example of price ceiling or price cap) makes high rents illegal
Housing stocks lower then unregulated
Shortage excess demand
Opportunity cost is now equal to the price of the good and the value of the search time
Minimum Wage (price floors)
Government regulation that makes it illegal to lower a price below a certain level value
Below equilibrium no effect
Creates excess supply labour and a shortage of quantity of labour demanded
This is a good idea depending on the elasticity of demand for labour
Elastic huge unemployment
Inelastic not much unemployment
Efficiency and equity
If prices are not allowed to adjust then quantities will
Market price solution may be efficient but may not be equitable
Tax demand
Tax incidence the division of a burden of tax between buyers and sellers
Buyers respond to the price that includes the tax while sellers respond to the price that excludes the tax
Perfectly inelastic demand buyers pay all
Perfectly elastic demand sellers pay all
Tax supply
Perfectly inelastic supply sellers pay all
Perfectly elastic supply buyers pay all
Tax drives a wedge between buying price and selling price and results in inefficient underproduction
Tax makes MSB>MSC, shrinks producer and consumer surplus and creates a deadweight loss
When political leaders debate taxes it is often fairness, not incidence and efficiency, that gets the most
attention
Economists propose how conflicting principles of fairness to apply to a tax system`:
1) The benefits principle
2) The ability to pay principle