We will now analyze government policy with respect to price controls, and its effects using the supply and demand microeconomic model. Principle of Economics #6: Markets are usually a good way to organize, track, and analyze economic activity.
Governments often wish to influence the market outcome by imposing price ceilings or floors. A price ceiling is the maximum price that businesses may be charged for a product due to external influences, and usually limits the price of a good to reach its free market equilibrium price. Examples can be found in rent controls, gasoline prices, and caps on doctor fees. If the ceiling price is below the equilibrium, it will result in:
Price floors are minimum prices that artificially raise the equilibrium price of products above the free market point. Examples of price floors are minimum wages, and agricultural marketing boards. If price floors are binding, then it will tend to reduce quantity demanded by citizens, and increase quantity supplied. Naturally, this will cause a surplus in the market since supply will exceed demand.
Most economists believe that minimum wage laws cause some unemployment, especially among teenagers, since businesses need to pay higher wages. It is estimated that a 10% increase in minimum wage generally leads to a 1-3% decline in employment of teenagers.
Incidence of tax again depends on the relative shape of the curves and is calculated by:
Generally speaking, when demand is more elastic than supply, the producer pays more. When demand is less elastic than supply, the consumer will pay more.
Governments often wish to influence the market outcome by imposing price ceilings or floors. A price ceiling is the maximum price that businesses may be charged for a product due to external influences, and usually limits the price of a good to reach its free market equilibrium price. Examples can be found in rent controls, gasoline prices, and caps on doctor fees. If the ceiling price is below the equilibrium, it will result in:
- Lower quantity supplied
- Higher quantity demanded
Price floors are minimum prices that artificially raise the equilibrium price of products above the free market point. Examples of price floors are minimum wages, and agricultural marketing boards. If price floors are binding, then it will tend to reduce quantity demanded by citizens, and increase quantity supplied. Naturally, this will cause a surplus in the market since supply will exceed demand.
Most economists believe that minimum wage laws cause some unemployment, especially among teenagers, since businesses need to pay higher wages. It is estimated that a 10% increase in minimum wage generally leads to a 1-3% decline in employment of teenagers.
Taxes and Their Incidence
Who pays taxes levied on products? What happens to the equilibrium price? It depends on the shape of the demand and supply curves, but generally price does not rise as much as the tax rises. Tax drives a wedge between the price paid by the consumer (gross price) and the price received by the producer (net price). Note that "net price" equals "gross price" minus "tax per unit".Incidence of tax again depends on the relative shape of the curves and is calculated by:
- Consumers pay gross price - original price.
- Producers pay original price - net price.
Generally speaking, when demand is more elastic than supply, the producer pays more. When demand is less elastic than supply, the consumer will pay more.
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