In this chapter you will examine the effects of government policies that place a ceiling on prices, examine the effects of government policies that put a floor under prices, consider how a tax on a good affects the price of the good and the quantity sold, learn that taxes levied on buyers and taxes levied on sellers are equivalent. | 6 Supply, Demand, and Government Policies Supply, Demand, and Government Policies In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. While equilibrium conditions may be efficient, it may be true that not everyone is satisfied. One of the roles of economists is to use their theories to assist in the development of policies. 2 2 CONTROLS ON PRICES Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Result in government-created price ceilings and floors. 3 3 CONTROLS ON PRICES 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. 4 4 How Price Ceilings Affect Market Outcomes Two outcomes are possible when the government imposes a price ceiling: The price ceiling is not binding if set above the equilibrium price. The price ceiling is binding if set below the equilibrium price, leading to a shortage. 5 5 . | 6 Supply, Demand, and Government Policies Supply, Demand, and Government Policies In a free, unregulated market system, market forces establish equilibrium prices and exchange quantities. While equilibrium conditions may be efficient, it may be true that not everyone is satisfied. One of the roles of economists is to use their theories to assist in the development of policies. 2 2 CONTROLS ON PRICES Are usually enacted when policymakers believe the market price is unfair to buyers or sellers. Result in government-created price ceilings and floors. 3 3 CONTROLS ON PRICES 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. 4 4 How Price Ceilings Affect Market Outcomes Two outcomes are possible when the government imposes a price ceiling: The price ceiling is not binding if set above the equilibrium price. The price ceiling is binding if set below the equilibrium price, leading to a shortage. 5 5 Figure 1 A Market with a Price Ceiling (a) A Price Ceiling That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity $4 Price ceiling Equilibrium price Demand Supply 3 100 Figure 1 A Market with a Price Ceiling Copyright©2003 Southwestern/Thomson Learning (b) A Price Ceiling That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply 2 Price ceiling Shortage 75 Quantity supplied 125 Quantity demanded Equilibrium price $3 How Price Ceilings Affect Market Outcomes Effects of Price Ceilings A binding price ceiling creates shortages because QD > QS. Example: Gasoline shortage of the 1970s nonprice rationing Examples: Long lines, discrimination by sellers 14 11 In 1973, OPEC raised the price of crude oil in world markets. Crude oil is the major input in gasoline, so the higher oil prices reduced the supply of gasoline. What was responsible for the long gas lines? CASE STUDY: Lines at the Gas Pump Economists blame government .
