Demand, Supply and Government Policy

Topic 5 – Demand, Supply and government policy (Week five Oct 6th – Oct 13th)
Outline: 1. Price Ceiling: -- General Analysis; -- Example: Rent Control; 2. Price Floor: -- General Analysis; -- Example: minimum wage law; 3. The Incidence of Sales Tax -- Key Results; -- Numerical Examples: a)Tax levied on sellers; b)Tax levied on buyers; -- Elasticities of demand and supply;

 Price Ceiling
A legal maximum on the price at which a good can be sold 1) General Analysis
Price 12 PE 8 Shortage 16 QE Price Ceiling DD Quantity

Price Ceiling
SS

Observation: a).Price ceiling, which is beneath the market clearing price (equilibrium price), creates shortage; b). Principle of voluntary exchange: Q(p) = minimum [QD(p), QS(p)] (Cannot force firm to produce more when they don’t want to; cannot force consumer to demand less when they want to);

c). Non-price rationing: free markets ration goods with price. Markets under price ceiling develop the rationing mechanism that is both inefficient and unfair (discriminative); d).Those who able to buy at the price ceiling could resell to other buyers at the “black market” at price of $12 (black market price)

ECO100Y1-Pesando-Notes edited by Eva Wu

2. Example: Rent Control (introduced into Ontario in 1970s): Rent
Price SS

PE Price falls P Shortage Price Ceiling DD QS QE Housing available falls QD Quantity

Economic Concerns with Rent Controls: a). Shortage of available places for rent; b). Incentive effect: -- discourage construction; (shortage worsen in the long run); -- discourage maintenance and other housing services; c) under-table-payments which essentially bring the price up closer to the equilibrium price; Why bother introducing rent control: Political response due to increasing population (election purpose)

 Price Floor
A legal minimum on the price at which a good can be sold General Analysis & Example: Minimum Wage Laws Minimum Wage
Price SS Price Floor (minimum wage) Surplus

P Price rises PE