University:
Kentucky State University
Course:
ECO 301 | Microeconomics
Academic year:

2020
Views:

377

Pages:

2
Author:

ilikemyicons0y5

Chapter 6 Supply, Demand and Government Policies Price ceiling A legal maximum on the price at which a good can be sold The price ceiling is a binding constraint if it is lower than the equilibrium price and a shortage is created Example: Rent control (shortage of quality housing, disincentive for building maintenance) Price floor A legal minimum on the price at which a good can be sold The price floor is a binding constraint if it is higher than the equilibrium price and a surplus is created Example: minimum wage (Higher unemployment rate especially for teenage and low skilled workers) Taxes (Per unit tax) Tax on sellers If the government requires the seller to pay a certain dollar amount for each unit of a good sold, the supply curve will shift left by the exact amount of the tax. Tax on buyers If the government requires the buyer to pay a certain dollar amount for each unit of a good purchased, the demand curve will shift left by the exact amount of the tax.    In both cases, the quantity of the good sold will decline Buyers and sellers will share the burden of the tax. Buyers pay more for the good and sellers receive less. The tax burden does not depend on whether the tax is imposed on buyers or sellers. 4 Elasticity and Tax Incidence  Tax incidence: the manner in which the burden of a tax is shared among participants in a market.  A tax burden falls more heavily on the side of the market that is less elastic. Example: Chapter 6, Q2 The government has decided that the free-market price of cheese is too low. (a) Suppose the government imposes a binding price floor in the cheese market. Draw a supply and demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese? (b) Producers of cheese complain that the price floor has reduced their total revenue. Is this possible? Explain. (c) In response to cheese producers’ complaints, the government agrees to purchase all the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses? (a) In the absence of the price floor, the price would be P1 and the quantity would be Q1. With the floor set at Pf, which is greater than P1, the quantity demanded is Q2, while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 – Q2. (b) The producers’ complaint that their total revenue has declined is correct if demand is elastic. With elastic demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline. (c) If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose. Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially. However, consumers would buy only quantity Q2 of cheese, so they are in the same position as before. Taxpayers lose because they would be financing the purchase of the surplus cheese through higher taxes. 5

Chapter 6 Supply, Demand and Government Policies

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