Transcript Ch. 4 PP notes - Mr. Lamb

Chapter 4:
Government intervention in markets
 Price controls
Price ceiling
Price floor
 Quantity controls—
quota
 Inefficiency
 Excise tax
 Excess burden
 Tax incidence
 Deadweight loss
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The Market for Apartments in the Absence
of Government Controls
Without government intervention, the market for apartments reaches
equilibrium at point E with a market rent of $1,000 per month and 2
million apartments rented.
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The Effects of a Price Ceiling
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Price ceilings cause inefficiency!
Inefficiency = missed opportunities: Some people
could be made better off without making other
people worse off.
Price ceilings often lead to inefficiency in the forms
of:
Inefficient allocation to consumers
If prices were allowed to go higher, some
people would give up their apartments, allowing
people who were willing to pay more to rent
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Wasted resources
Because price ceilings cause a shortage,
potential buyers have to wait in lines, or
spend more time to make a transaction.
Inefficiently low quality
Why would a landlord fix up an apartment
when rents cannot be increased?
They also produce black markets, or illegal
transactions.
Example: Trout and salmon from Lake Michigan.
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The Market for Butter with no Government
Controls
Without government intervention, the market for butter reaches
equilibrium at a price of $1 per pound and with 10 million pounds of butter
bought and sold.
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The Effects of a Price Floor
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Price Floors Cause Inefficiency!
The most familiar price floor is the minimum wage.
Price floors are also commonly imposed on agricultural
goods.
Price floors often lead to inefficiency in the forms of:
Inefficient allocation of sales among sellers
Wasted resources
What happens to surplus butter?
Inefficiently high quality
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So why are there price floors?
Price floors benefit some influential sellers.
Government officials believe their actions will correct
the market.
Political concerns are more important!
Campaign contributions - Lobbyists
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Controlling Quantities
A quantity control, or quota, is an upper limit on
the quantity of some good that can be bought or sold.
The total amount of the good that can be legally
transacted is the quota limit.
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The Market for Taxi Rides in the Absence
of Government Controls
Without government intervention, the market reaches equilibrium with 10
million rides taken per year at a fare of $5 per ride.
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Effect of a Quota on the Market for Taxi Rides
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A quota drives a wedge between the demand
price (the price paid by buyers) and the supply
price (the price received by sellers) of a good.
The difference between the demand and
supply price at the quota limit is the quota
rent, the earnings that accrue to the licenseholder. In this example, the license itself is
worth $2.00 per ride to the license holder.
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Excise Taxes
Excise taxes are taxes on the purchase or sale of a
good.
They have effects similar to quotas:
 raise the price paid by buyers and
 reduce the price received by sellers,
and drive a wedge between the two.
Examples: Excise tax levied on sales of taxi rides and
excise tax levied on purchases of taxi rides
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Effect of an Excise Tax Levied on the
Sales of Taxi Rides – Taxi owner pays tax
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Effect of an Excise Tax Levied on the
Purchases of Taxi Rides – tax paid by taxi
customers
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The incidence of a tax is a measure of who really
pays it.
Who really bears the tax burden (higher prices to
consumers and lower prices to sellers) does not depend
on who officially pays the tax. Depending on the shapes
of supply and demand curves, the incidence of an excise
tax may be divided differently.
The wedge between the demand price and supply price
becomes the government’s tax revenue.
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The Revenue from an Excise Tax
Area of
triangle
ABE =
deadweight
loss
Area of the shaded rectangle:
$2 per ride × 8 million rides = $16 million.
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Excise taxes also cause inefficiency: excess burden
or deadweight loss.
This excess burden, or deadweight loss, means
that the true cost is always larger than the amount
paid in taxes.
Excise taxes prevent some mutually beneficial
transactions.
They also encourage illegal activity in attempts to
avoid the tax.
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The End of Chapter 4
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