Government Market Intervention: Price Ceilings/Floors and Taxes (Sheet prints on one landscaped page.

The PriceCeling and PriceFloor sheets enables a series of experiments on different demand and supply curves in order to learn about price ceilings and floors.
The Taxes sheet shows how tax incidence is determined by the price elasticities of demand and supply.

Background Reading Before You Begin

There are many ways that government can "intervene" in the market, including product labeling laws, worker safety legislation, zoning restrictions and on and on.

This workbook focuses on just two types of interventions:

1) Price restrictions
2) Per unit taxes on particular goods

These two types of government interventions are quite common and can be easily handled by Supply and Demand analysis.

1) Price restrictions take the form of maximum (price ceilings) or minimum (price floors) prices for which a good may be legally sold (green color on the graphs below).
A price ceiling leads to a persistent shortage of the good and a price floor leads to a persistent surplus.

P S P S
Price Floor

Price Ceiling
Qe D Qe D
Q Q
Qs Qd Qd Qs
Shortage Surplus

Key One important aspect of price regulations are that they impair the market's ability to allocate resources.
Concept In the case of the price ceiling, too little output is produced because the quantity supplied at the legally mandated price is below the unregulated equilibrium quantity.
With a price floor, too much output is produced because the quantity supplied at the minimum legal price is greater than the equilibrium quantity.
In both cases, price regulations distort the allocation of resources. By not allowing prices to rise or fall, the price regulation causes too little or too much output to be produced.
In fact, the case against price regulations rides on an important assumption, that Qe (the unregulated equilibrium quantity) is the optimal quantity.
This is only true for well-behaved, competitive markets.
Further study in economics will explain under what conditions the free market equilibrium quantity is optimal and measure in dollars the cost of the distortion.

Key Price regulations have a second drawback.

Concept Maintaining price ceilings and floors requires pressure to counteract the market's push on prices.
In the case of ceilings, illegal sales must be prevented and alternative ways to allocate the available Qs among the buyers must be used.
With floors, policies (such as government purchase of the excess supply) must be implemented to maintain price supports.

2) Taxes
Governments routinely tax specific commodities. Gasoline, liquor, and cigarettes are taxed by governments around the world.
P S+Tax
Amount of Tax
S
PBuyer

PSeller
Qe D
Q
Qe
w/ tax
Once the tax is imposed, the market is allowed to operate freely and it equilibrates at the point where S+Tax=D.
There are two issues to consider:
Key 1) The new Qe with the tax (Qe w/ tax) is lower than the original equilibrium quantity (plain Qe).
Concept Thus, the tax has distorted the allocation of resources (less of this good is produced than without the tax).
This is the same problem that we identified with price regulations.
If you believe the untaxed market's Qe is optimal, then Qe w/ tax is obviously sub-optimal.
Key 2) Buyers pay more and sellers receive less than when there was no tax.
Concept The question of who bears the bigger burden, called tax incidence, is an interesting one.
You would think that if the supplier is responsible for paying the tax to the government, then the supplier bears the burden of the tax.
A moment's reflection should convince you that this is untrue. After all, the seller might be able to charge higher prices and simply pass on the tax.
If property taxes rise, it is quite possible that the landlord will charge higher rent, thereby passing on the tax.
In that case, it's the renter who bears the burden of the tax, not the landlord.

Key Concept
The sheets in this workbook will show that the effects of price regulations and taxes crucially depend on the price elasticities of demand and supply.
This sheet enables you to set different price ceilings and demand curves in order to see the effects on the market.
Use the scroll bars to change cells and see how the market is impacted.
Click on the list of elasticity values to set the Price elasticity of Demand at P=100.

Parameters for Demand and Supply

P = d0 - d1Qd P = s0 + s1Qs
d0 350 350 s0 35 35
d1 2 200 s1 0.52 52

500
Free Market Equilibrium Solution

Price in $/unit
Pe 100 450
Qe 125 400
350
Price Ceiling 50 0 300
Qd 150
250
Qs (amount sold) 29
Shortage 121 200
Q Distortion 96 150

Elasticities at the Initial Equilibrium Price 100

P elasticity D = -0.2 50
P elasticity of D at P = 100: -0.4 P elasticity D = -0.4
P elasticity D = -0.8 0
P elasticity of S at P = 100: 1.5 P elasticity D = -1.6 0 50 100 Quantity 150 200

Black Market Price 292

step
8 Live
Q D S Price Line
0 350 35 50
8 334 39.16 50
16 318 43.32 50
 24 302 47.48 50
32 286 51.64 50
40 270 55.8 50
48 254 59.96 50
56 238 64.12 50
64 222 68.28 50
72 206 72.44 50
80 190 76.6 50
88 174 80.76 50
96 158 84.92 50
104 142 89.08 50
112 126 93.24 50
120 110 97.4 50
128 94 101.56 50
136 78 105.72 50
144 62 109.88 50
152 46 114.04 50
160 30 118.2 50
168 14 122.36 50
176 0 126.52 50
184 0 130.68 50
192 0 134.84 50
200 0 139 50
208 0 143.16 50
216 0 147.32 50
224 0 151.48 50
232 0 155.64 50
240 0 159.8 50
248 0 163.96 50
n the market.

tity 150 200 250

Dead List Box Data

D S P elasticity D = -0.2 2
350 35 P elasticity D = -0.4
334 39.16 P elasticity D = -0.8
318 43.32 P elasticity D = -1.6
302 47.48
286 51.64
270 55.8
254 59.96 Qd
238 64.12 150 0
222 68.28 150 50
206 72.44
190 76.6 Qs
174 80.76 29 0
158 84.92 29 50
142 89.08
126 93.24 Black Market
110 97.4 29 50
94 101.56 29 292
78 105.72 0 292
62 109.88
46 114.04
30 118.2
14 122.36
0 126.52
0 130.68
0 134.84
0 139
0 143.16
0 147.32
0 151.48
0 155.64
0 159.8
0 163.96
This sheet is just like the PriceCeiling sheet, except we're now working with a price floor (a minimum price below which the go
Unlike ceilings, which generate persistent shortages, floors prevent the market from eliminating surpluses by cutting the price.

Parameters for Demand and Supply

P = d0 - d1Qd P = s0 + s1Qs
d0 350 350 s0 35
d1 2 200 s1 0.52

500
Free Market Equilibrium Solution

Price in $/unit
Pe 100 450
Qe 125 400
350
Price Floor 125 300
Qd (amount sold) 113
250
Qs 173
Surplus 60 200
Q Distortion 48 150

Elasticities at the Initial Equilibrium Price 100

P elasticity D = -0.2 50
P elasticity of D at P = 100: -0.4 P elasticity D = -0.4
P elasticity D = -0.8 0
P elasticity of S at P = 100: 1.5 P elasticity D = -1.6 0 50 100 Quantity 150 200

step
8 Live
Q D S Price Line
0 350 35 125
8 334 39.16 125
16 318 43.32 125
 24 302 47.48 125
32 286 51.64 125
40 270 55.8 125
48 254 59.96 125
56 238 64.12 125
64 222 68.28 125
72 206 72.44 125
80 190 76.6 125
88 174 80.76 125
96 158 84.92 125
104 142 89.08 125
112 126 93.24 125
120 110 97.4 125
128 94 101.56 125
136 78 105.72 125
144 62 109.88 125
152 46 114.04 125
160 30 118.2 125
168 14 122.36 125
176 0 126.52 125
184 0 130.68 125
192 0 134.84 125
200 0 139 125
208 0 143.16 125
216 0 147.32 125
224 0 151.48 125
232 0 155.64 125
240 0 159.8 125
248 0 163.96 125
inimum price below which the good cannot be legally sold).
ng surpluses by cutting the price.

35
52

100 Quantity 150 200 250

Dead List Box Data

D S P elasticity D = -0.2 2
350 35 P elasticity D = -0.4
334 39.16 P elasticity D = -0.8
318 43.32 P elasticity D = -1.6
302 47.48
286 51.64
270 55.8
254 59.96 Qd
238 64.12 113 0
222 68.28 113 125
206 72.44
190 76.6 Qs
174 80.76 173 0
158 84.92 173 125
142 89.08
126 93.24
110 97.4
94 101.56
78 105.72
62 109.88
46 114.04
30 118.2
14 122.36
0 126.52
0 130.68
0 134.84
0 139
0 143.16
0 147.32
0 151.48
0 155.64
0 159.8
0 163.96
This sheet shows what happens when a per unit tax is imposed on a good.
While the seller is responsible for collecting the tax, the tax incidence depends on the elasticities of demand and supply.
Prices have been rounded to the nearest penny.

Exogenous Variables for Demand and Supply

P = d0 - d1Qd P = s0 + s1Qs
d0 350 350 s0 35 35
d1 2 200 s1 0.52 52
500
Market Equilibrium Solution

Price in $/unit
Pe 100 450
Qe 125 400

350
Tax 0 100
P Consumer 100 300
P Firm 100 250
Gov Rev 0 200

150
Initial, No Tax Solution
Pe 100 100
Qe 125 50

0
Q Distortion 0
0 50 100 Quantity 150 200 250

Elasticities at the Initial Equilibrium Price Elasticities at the Equilibrium Price

P elasticity D = -0.2 P elasticity of D at P = 100: -0.4
P elasticity of D at P = 100: -0.4 P elasticity D = -0.4 P elasticity of S at P = 100: 1.5
P elasticity D = -0.8
P elasticity of S at P = 100: 1.5 P elasticity D = -1.6

step
8 Live Dead
Q D S Price Line D
0 350 35 100 350
8 334 39.16 100 334
16 318 43.32 100 318
 24 302 47.48 100 302
32 286 51.64 100 286
40 270 55.8 100 270
48 254 59.96 100 254
56 238 64.12 100 238
64 222 68.28 100 222
72 206 72.44 100 206
80 190 76.6 100 190
88 174 80.76 100 174
96 158 84.92 100 158
104 142 89.08 100 142
112 126 93.24 100 126
120 110 97.4 100 110
128 94 101.56 100 94
136 78 105.72 100 78
144 62 109.88 100 62
152 46 114.04 100 46
160 30 118.2 100 30
168 14 122.36 14
176 -2 126.52 -2
184 -18 130.68 -18
192 -34 134.84 -34
200 -50 139 -50
208 -66 143.16 -66
216 -82 147.32 -82
224 -98 151.48 -98
232 -114 155.64 -114
240 -130 159.8 -130
248 -146 163.96 -146
lasticities of demand and supply.

150 200 250

at the Equilibrium Price

of D at P = 100: -0.4
of S at P = 100: 1.5

List Box Data

S Price Line P elasticity D = -0.2 2
35 100 P elasticity D = -0.4
39.16 100 P elasticity D = -0.8
43.32 100 P elasticity D = -1.6
 47.48 100
51.64 100 No Tax Dashed Lines
55.8 100 0 100
59.96 100 125 100
64.12 100 125 0
68.28 100
72.44 100 Tax Dashed Lines
76.6 100 0 100
80.76 100 125 100
84.92 100 125 0
89.08 100
93.24 100 Seller's Price Dashed Line
97.4 100 0 100
101.56 100 125 100
105.72 100
109.88 100
114.04 100
118.2 100
122.36
126.52
130.68
134.84
139
143.16
147.32
151.48
155.64
159.8
163.96