CHAPTER 6: Supply, Demand, and Government Policies 6-1 Controls On Prices

Nadiya Alya Fitri
1902113027
Accounting (English Class)
CHAPTER 6: Supply, Demand, and Government Policies
6-1 Controls on Prices

Because buyers of any good always want a lower price while sellers want a higher price,
the interests of the two groups conflict.
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
6-1a How Price Ceilings Affect Market Outcomes

In this case, because the price that balances supply and demand is below the ceiling, the
price ceiling is not binding. Market forces naturally move the economy to the equilibrium, and
the price ceiling has no effect on the price or the quantity sold.
This example in the market for ice cream shows a general result: When the government
imposes a binding price ceiling on a competitive market, a shortage of the good arises, and
sellers must ration the scarce goods among the large number of potential buyers. The rationing
mechanisms that develop under price ceilings are rarely desirable. Long lines are inefficient
because they waste buyers’ time. Discrimination according to seller bias is both inefficient
(because the good may not go to the buyer who values it most highly) and often unfair. By
contrast, the rationing mechanism in a free, competitive market is both efficient and impersonal.
When the market for ice cream reaches its equilibrium, anyone who wants to pay the market
price can get a cone. Free markets ration goods with prices.
6-1b How Price Floors Affect Market Outcomes

In panel (a), the government imposes a price floor of $2. Because this is below the
equilibrium price of $3, the price floor has no effect. The market price adjusts to balance supply
and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones.
In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of
$3. Therefore, the market price equals $4. Because 120 cones are supplied at this price and only
80 are demanded, there is a surplus of 40 cones.
6-1c Evaluating Price Controls
This principle explains why economists usually oppose price ceilings and price floors. To
economists, prices are not the outcome of some haphazard process. Prices, they contend, are the
result of the millions of business and consumer decisions that lie behind the supply and demand
curves. Prices have the crucial job of balancing supply and demand and, thereby, coordinating
economic activity. When policymakers set prices by legal decree, they obscure the signals that
normally guide the allocation of society’s resources.
6-2 Taxes
The term tax incidence refers to how the burden of a tax is distributed among the various
people who make up the economy.
6-2a How Taxes on Sellers Affect Market Outcomes

Step One The immediate impact of the tax is on the sellers of ice cream. Because the tax is not
levied on buyers, the quantity of ice cream demanded at any given price is the same; thus, the
demand curve does not change. By contrast, the tax on sellers makes the ice-cream business less
profitable at any given price, so it shifts the supply curve.
Step Two Because the tax on sellers raises the cost of producing and selling ice cream, it reduces
the quantity supplied at every price. The supply curve shifts to the left (or, equivalently, upward).
Step Three Having determined how the supply curve shifts, we can now compare the initial and
the new equilibriums. Figure 6 shows that the equilibrium price of ice cream rises from $3.00 to
$3.30, and the equilibrium quantity falls from 100 to 90 cones. Because sellers sell less and
buyers buy less in the new equilibrium, the tax reduces the size of the ice-cream market.
A Tax on Sellers
When a tax of $0.50 is levied on sellers, the supply curve shifts up by $0.50 from S1 to S2. The
equilibrium quantity falls from 100 to 90 cones. The price that buyers pay rises from $3.00 to
$3.30. The price that sellers receive (after paying the tax) falls from $3.00 to $2.80. Even though
the tax is levied on sellers, buyers and sellers share the burden of the tax.
Implications
To sum up, this analysis yields two lessons:
1. Taxes discourage market activity. When a good is taxed, the quantity of the good sold is
smaller in the new equilibrium.
2. Buyers and sellers share the burden of taxes. In the new equilibrium, buyers pay more for the
good, and sellers receive less.
6-2b How Taxes on Buyers Affect Market Outcomes
Step One The initial impact of the tax is on the demand for ice cream. The supply curve is not
affected because, for any given price of ice cream, sellers have the same incentive to provide ice
cream to the market. By contrast, buyers now have to pay a tax to the government (as well as the
price to the sellers) whenever they buy ice cream. Thus, the tax shifts the demand curve for ice
cream.
Step Two Next, we determine the direction of the shift. Because the tax on buyers makes buying
ice cream less attractive, buyers demand a smaller quantity of ice cream at every price.
Step Three Having determined how the demand curve shifts, we can now see the effect of the
tax by comparing the initial equilibrium and the new equilibrium. And once again, buyers and
sellers share the burden of the tax. Sellers get a lower price for their product; buyers pay a lower
market price to sellers than they did previously, but the effective price (including the tax buyers
have to pay) rises from $3.00 to $3.30.
Implications
Taxes levied on sellers and taxes levied on buyers are equivalent. In both cases, the tax
places a wedge between the price that buyers pay and the price that sellers receive. The wedge
between the buyers’ price and the sellers’ price is the same, regardless of whether the tax is
levied on buyers or sellers. In either case, the wedge shifts the relative position of the supply and
demand curves. In the new equilibrium, buyers and sellers share the burden of the tax. The only
difference between a tax levied on sellers and a tax levied on buyers is who sends the money to
the government.
Once the market reaches its new equilibrium, buyers and sellers share the burden,
regardless of how the tax is levied.
6-2c Elasticity and Tax Incidence
A payroll tax places a wedge between the wage that workers receive and the wage that
firms pay. Comparing wages with and without the tax, you can see that workers and firms share
the tax burden. This division of the tax burden between workers and firms does not depend on
whether the government levies the tax on workers, levies the tax on firms, or divides the tax
equally between the two groups.
How the Burden of a Tax Is Divided In panel (a), the supply curve is elastic, and the demand
curve is inelastic. In this case, the price received by sellers falls only slightly, while the price
paid by buyers rises substantially. Thus, buyers bear most of the burden of the tax. In panel (b),
the supply curve is inelastic, and the demand curve is elastic. In this case, the price received by
sellers falls substantially, while the price paid by buyers rises only slightly. Thus, sellers bear
most of the burden of the tax.

CHAPTER 6: Supply, Demand, and Government Policies 6-1 Controls On Prices

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CHAPTER 6: Supply, Demand, and Government Policies 6-1 Controls On Prices

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Nadiya Alya Fitri

CHAPTER 6: Supply, Demand, and Government Policies

6-1 Controls on Prices

6-1a How Price Ceilings Affect Market Outcomes

6-1b How Price Floors Affect Market Outcomes

6-2a How Taxes on Sellers Affect Market Outcomes

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