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Questions and Answers
What is a binding price ceiling?
What is a binding price ceiling?
Which of the following is an example of government intervention via price floor?
Which of the following is an example of government intervention via price floor?
What is the primary effect of a price ceiling set below the equilibrium price?
What is the primary effect of a price ceiling set below the equilibrium price?
Why do governments impose price controls?
Why do governments impose price controls?
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What occurs when a price floor is set above the equilibrium price?
What occurs when a price floor is set above the equilibrium price?
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Which of these is NOT a direct effect of government intervention in markets?
Which of these is NOT a direct effect of government intervention in markets?
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How does a price ceiling affect supplier behavior?
How does a price ceiling affect supplier behavior?
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In the context of a price ceiling, what happens to the quantity demanded when the price is lower than the equilibrium price?
In the context of a price ceiling, what happens to the quantity demanded when the price is lower than the equilibrium price?
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Study Notes
Government Intervention
- Government intervention in markets occurs when the government modifies market activities.
- Reasons government intervenes include providing essential services (e.g., electricity, water) and correcting market failures or inefficiencies (e.g., drugs, monopolies).
- Price controls are interventions that affect prices.
Price Controls
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Price Ceiling: A legal maximum price at which a good can be sold (e.g., bread, rent control).
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A price ceiling below the equilibrium price results in a shortage (quantity demanded exceeds quantity supplied).
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Price Floor: A legal minimum price at which a good can be sold (e.g., minimum wage).
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A price floor above the equilibrium price results in a surplus (quantity supplied exceeds quantity demanded).
Taxes
- Taxes imposed on sellers affect prices and the market's quantity traded.
- Consumers indirectly bear a portion of the tax burden.
- Suppliers also bear a portion of the tax burden.
- The tax burden shifts depending on the elasticity of supply and demand (more inelastic side bears more of the burden).
Question 1A
- Binding price ceilings are those set below the equilibrium price.
- A binding price ceiling results in a shortage, where quantity demanded exceeds quantity supplied.
- At a binding price ceiling, a portion of consumers will have no way to access the product/good.
- Producers will be less incentivized to produce/offer as there's less profit.
- Equilibrium price where quantity supplied and quantity demanded meet.
Question 1B
- Binding price floors are those set above the equilibrium price.
- A binding price floor results in a surplus, where quantity supplied exceeds quantity demanded.
- If equilibrium price remains too low, there is a surplus of product in the market, as there are more producers than consumers.
- Producers will overproduce goods, resulting in a larger quantity available.
Question 2
- Tax imposed = amount paid by consumer - amount received by producer (seller).
- The tax burden is shared between consumers and producers (sellers).
Question 2 (Values)
- The value of the tax is $2.5, derived by subtracting the price received from the price paid by consumers.
- The price paid by consumers is 6,andthepricereceivedbyproducers(sellers)is6, and the price received by producers (sellers) is 6,andthepricereceivedbyproducers(sellers)is3.5.
- Equilibrium quantity x tax imposed = tax revenue, which in this case is $125.
Question 2 (Taxes)
- The tax burden falls more heavily on the side of the market with lower elasticity, either supply or demand.
- Supply side elasticity: the ease of adjusting production in response to price changes.
- Demand side elasticity: the ease of adjusting consumption in response to price changes.
Question 3 (Payroll Tax)
- Payroll tax: If imposed on employers, it will shift the supply curve to the left for labor.
- The result is an increase in the price for employees (wage); however, the amount of the wage increase is less than the tax amount.
Question 3 (Market Failures)
- Market failure occurs when the free market fails to allocate goods and services efficiently.
- Market failures occur in the cases of:
- Positive externalities or negative externalities.
- Inequality
- Natural monopolies
- Public Goods Production.
Question 3 (Price Floor/Tax)
- Tax on cigarettes (or any good) creates a price disequilibrium, where consumers pay more and producers receive less, with price differences equaling tax rate.
- A price floor increases the price and incentivizes producers to increase supply, but demand may not increase as much resulting in surplus.
Case 2 (Extra Exercise)
- When a payroll tax is proposed on firms, the tax incidence (burden) is divided between firms and employees (workers).
- The side with less elasticity (e.g., workers, especially lower income) bears most of the burden.
- Increasing payroll taxes on firms will likely increase tax revenue but decrease wages for workers.
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Description
This quiz explores the concept of government intervention in markets, including reasons for intervention and its impact on price controls, taxes, and market efficiency. You'll learn about price ceilings, price floors, and how taxes influence buyer and seller behavior. Test your understanding of these crucial economic principles.
