Macro
CH6: Supply, Demand, and Government Policies
Summary:
• A price ceiling is a legal maximum on the price of a good. An
example is rent control. If the price ceiling is below the equilibrium
price, it is binding and causes a shortage.
• A price floor is a legal minimum on the price of a good. An example
is the minimum wage. If the price floor is above the equilibrium
price, it is binding and causes a surplus. The labor surplus caused by
the minimum wage is unemployment.
• A tax on a good places a wedge between the price buyers pay and
the price sellers receive, and causes the equilibrium quantity to fall,
whether the tax is imposed on buyers or sellers.
• The incidence of a tax is the division of the burden of the tax
between buyers and sellers, and does not depend on whether the
tax is imposed on buyers or sellers.
• The incidence of the tax depends on the price elasticities of supply
and demand.
• A price ceiling is a legal maximum on the price of a good or service.
An example is rent control. If the price ceiling is below the
equilibrium price, then the price ceiling is binding, and the quantity
demanded exceeds the quantity supplied. Because of the resulting
shortage, sellers must in some way ration the good or service among
buyers.
• A price floor is a legal minimum on the price of a good or service. An
example is the minimum wage. If the price floor is above the
equilibrium price, then the price floor is binding, and the quantity
supplied exceeds the quantity demanded. Because of the resulting
surplus, buyers’ demands for the good or service must in some way
be rationed among sellers.
• When the government levies a tax on a good, the equilibrium
quantity of the good falls. That is, a tax on a market shrinks the size
of the market.
• A tax on a good places a wedge between the price paid by buyers
and the price received by sellers. When the market moves to the
new equilibrium, buyers pay more for the good and sellers receive
less for it. In this sense, buyers and sellers share the tax burden. The
incidence of a tax (that is, the division of the tax burden) does not
depend on whether the tax is levied on buyers or sellers.
• The incidence of a tax depends on the price elasticities of supply and
demand. Most of the burden falls on the side of the market that is
less elastic because that side of the market cannot respond as easily
to the tax by changing the quantity bought or sold
price ceiling: a legal maximum on the price at which a good can be
sold
price floor: a legal minimum on the price at which a good can be sold
tax incidence: the manner in which the burden of a tax is shared
among participants in a market
Price Buyers Pay: Increases, leading to a decrease in quantity
demanded.
Price Sellers Receive: Decreases, leading to a decrease in quantity
supplied.
1.When the government imposes a binding price floor, it causes
d. a surplus of the good to develop
2.In a market with a binding price ceiling, an increase in the ceiling
will _____ the quantity supplied, ________ the quantity demanded,
and reduce the ________.
c. increase, decrease, shortage
3.A $1 per unit tax levied on consumers of a good is equivalent to a.
a $1 per unit tax levied on producers of the good.
4. Which of the following would increase quantity supplied, decrease
quantity demanded, and increase the price that consumers pay?
a. the imposition of a binding price floor
5. Which of the following would increase quantity supplied, increase
quantity demanded, and decrease the price that consumers pay?
d. the repeal of a tax levied on producers
6. When a good is taxed, the burden of the tax falls mainly on
consumers if
d. supply is elastic, and demand is inelastic
• Price controls are usually enacted when policymakers believe that
the market price of a good or service is unfair to buyers or sellers.
• Policymakers use taxes to raise revenue for public purposes and to
influence market outcomes.
• Taxes: government can make buyers or sellers pay a specific amount
on each unit
• Shortages and Rationing:
Because of shortage –Sellers must ration the goods among buyers
Some rationing mechanisms:
• Long lines
• Discrimination according to sellers’ biases
–Are often unfair and inefficient
• The goods do not necessarily go to the buyers who value them
most highly
• Evaluating Price Controls:
Markets are usually a good way to organize economic activity
–Economists usually oppose price ceilings and price floors
–Prices are not the outcome of some haphazard process –Prices
have the crucial job of balancing supply and demand
• Coordinating economic activity
Governments can sometimes improve market outcomes –Want to
use price controls
• Because of unfair market outcome
• Aimed at helping the poor
–Often hurt those they are trying to help
–Other ways of helping those in need
• Rent subsidies • Wage subsidies (earned income tax
credit
TAXES
1)Government uses taxes –To raise revenue for public
projects
• Roads, schools, and national defense
2)Tax incidence
– Manner in which the burden of a tax is shared among
participants in a market
• The government can make the seller or the buyer
to pay the tax
 Principle: Markets Are Efficient
Market Efficiency: One of the core principles of
economics is that markets are generally a good
way to organize economic activity.

Role of Prices: Prices in a free market are the

result of millions of decisions by businesses and
consumers. They help balance supply and
demand, coordinating economic activity.

Interference: When the government sets price

controls (like price ceilings and floors), it
disrupts these signals, leading to inefficiencies.

(a) Rent Control in the Short Run (supply and demand
are inelastic)
(b) Rent Control in the Long Run (supply and demand
are elastic)
Example of Disruption
Price Ceilings: Limit the maximum price that can
be charged (e.g., rent control). They can lead to
shortages because they increase demand but
decrease supply.
Price Floors: Set the minimum price (e.g.,
minimum wage). They can lead to surpluses
because they increase supply but decrease
demand.

Why Governments Implement Price Controls

Principle: Governments Can Improve Market
Outcomes
Perceived Unfairness: Policymakers may see the
market outcomes as unfair and try to correct
them to help the poor.
Examples:
Rent Control: To make housing affordable.
Minimum Wage: To help workers earn a living wage.
Q=90
Pb= 3.30
Ps=2.80
The economy is governed by two kinds of laws: the
Incidence of tax laws of supply and demand and the laws enacted by
buyers=0.30, pay more governments.
sellers=0.20, get less
Price controls and taxes are common in various
tax=0.50
markets in the economy, and their effects are
frequently debated in the press and among
Whether the tax is levied on buyers or sellers, the
policymakers.
market outcomes are EQUIVALENT.
The price that buyers pay (including the tax) increases.
The price that sellers receive (after the tax) decreases.

Supply is more elastic than

demand, It’s easier for sellers
than buyers to leave the market.
So buyers bear most of the
burden of the tax.

Demand is more elastic than

supply, It’s easier for buyers than
sellers to leave the market. Sellers
bear most of the burden of the
tax