Markets In Action
A price ceiling is a government regulation of the maximum price that may be legally charged. To see how a price ceiling works, we’ll examine its effects in a market for rental housing, when it is called a rent ceiling.
A Rental Housing Market
The demand for and supply of rental housing determine the equilibrium rent and the equilibrium quantity of rental housing available. A rent ceiling tries to change the rent. The effects of a rent ceiling depend crucially on whether the ceiling is binding or not binding. A rent ceiling is not binding if it is set above the equilibrium rent. A rent ceiling is binding if it set below the equilibrium rent. Let’s see how scarce housing resources get allocated in the face of a binding rent ceiling by examining two groups of mechanisms: -Lottery, queue and discrimination
Lottery, Queue and Discrimination
The time spent looking for someone with whom to do business is called search activity. The opportunity cost of a good is equal not only to its price but also to the value of the time spent searching the good.
A black market is an illegal market in which the price exceeds the legally imposed price ceiling.
Inefficiency of Rent Ceilings
Without a rent ceiling, the market determines the equilibrium rent and equilibrium quantity of housing. In this situation, scarce housing resources are allocated efficiently. Marginal social benefit equals marginal social cost.
A price floor is a regulation that makes it illegal to trade at a price lower than the specified level. Price floors are used in many markets. But when a price floor is applied to labor markets, it is called a minimum wage.
A Labor Market
In the labor market, employers are on the demand side and workers are on the supply side. The effects of a minimum wage depend crucially on whether the minimum is binding or not binding. A minimum wage is not binding if it set below the equilibrium wage rate. A minimum wage is binding if it is set above the equilibrium wage.
You’re going to discover that it isn’t obvious who really pays a tax and that lawmakers don’t make that decision. We begin with a definition of tax incidence.
Tax incidence is the division of the burden of a tax between the buyer and the seller. Tax incidence does not depend on the tax law. The law might impose a tax on sellers or on buyers, but the outcome is the same in either case.
Equivalence of Tax on Buyers and Sellers
Can We Share the Burden Equally? – The key point is that when a transaction is taxed, there are two prices: the price paid by buyers, which includes the tax; and the price received by sellers, which excludes the tax. Buyers respond only to the price that includes the tax because that is the price they pay. Sellers respond only to the price that excludes the tax because that is the price they receive. A tax is like a wedge between the buying price and the selling price. It is the size of the wedge, not the side of the market – demand side or supply side – on which the tax is imposed that determines the effects of the tax.
Tax Division and Elasticity of Demand
The division of the total tax between buyers and sellers depends partly on the elasticity of demand. There are two extreme cases: -Perfectly inelastic demand – sellers pay
-Perfectly elastic demand – buyers pay
Taxes in Practice
Supply and demand are rarely perfectly elastic or perfectly inelastic. But some items tend towards one of the extremes.
Taxes and Efficiency
The price sellers receive is also the sellers’ minimum supply price, which equals marginal cost. So because a tax puts a wedge between the buyers’ price and the sellers’ price, it also puts a wedge between marginal benefit and marginal cost and creates inefficiency. With a higher buyers’ price and a lower sellers’ price, the tax decreases the quantity produced and...