Economics Section 6 PDF

Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek Government Intervention in Markets First, Price Ceiling 1. What is Price Ceiling? A price ceiling or price cap is a regulation that makes it illegal to charge a price higher than a specified level...

Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek Government Intervention in Markets First, Price Ceiling 1. What is Price Ceiling? A price ceiling or price cap is a regulation that makes it illegal to charge a price higher than a specified level. Price ceilings are typically imposed on consumer staples, like food, gas, or medicine. 2. What is a rent ceiling and what are its effects if it is set above or below the equilibrium rent? A rent ceiling is a specific example of a price ceiling. A rent ceiling is a government-imposed regulation that makes it illegal to charge a rent higher than a specified level. A) A deadweight loss arises. B) Producer surplus shrinks. C) Consumer surplus shrinks. Above the equilibrium rent: If a rent ceiling is set above the equilibrium rent, it has no effect because it does not make the equilibrium rent illegal. The market works as if there were no ceiling. Below the equilibrium rent: If a rent ceiling is set below the equilibrium rent, it creates: A housing shortage: The quantity of housing units demanded by renters exceeds the quantity supplied by landlords. This creates a house shortage. Increases search activity: A rent ceiling that creates a shortage increases search activity. Search activity is costly and increases the opportunity cost of a given product or service. There is a potential loss from increased search activity. Define Black Market: A black market is an illegal market in which the price exceeds the legally- imposed price ceiling. A black market. A shortage of housing creates a black market in housing. In black market, illegal arrangements are made between renters and landlords at rents above the rent ceiling. A rent ceiling decreases the quantity of housing and the scarce housing is allocated by: Lottery: gives scarce housing to the lucky First-come, first-served: gives scarce housing to those who have the greatest foresight and get their names on the list first. Discrimination: allocates scarce housing based on the self-interest of the owner. Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek 3. How are scarce housing resources allocated when a rent ceiling is in place? With an effective rent ceiling, some means for allocation of housing units (other than by price) becomes necessary. Some housing is allocated by first-come, first-serve. Other housing is allocated by discrimination. Black markets also develop, where housing units are allocated at a rent higher than the regulated rent. Second: Price Floor 1. What is price floor? A price floor is a regulation that makes it illegal to trade at a price lower than a specified level. When a price floor is applied to labor markets, it is called a minimum wage. 2. What is a minimum wage and what are its effects if it is set above or below the equilibrium wage? A minimum wage is a price floor applied to the labor market. A minimum wage is a government imposed regulation that makes it illegal to charge (or pay) a wage rate lower than a specified level. Above the equilibrium price: If the minimum wage is set above the equilibrium wage, it creates a surplus of labor—unemployment—and decreases workers’ and firms’ surplus. Deadweight loss arises. Unemployment…Why?! The quantity of labor supplied by workers exceeds the quantity demanded by employers. This creates unemployment or "surplus of labor". The quantity of labor hired at the minimum wage is less than the quantity that would be hired in an unregulated labor market. Because the legal wage rate cannot eliminate the surplus, the minimum wage creates unemployment. Below the equilibrium prices: If the minimum wage is set below the equilibrium wage, then the law has no impact on the labor market equilibrium wage and quantity. It has no effect. The market works as if there were no minimum wage Explain why a minimum wage is unfair. The result is unfair because workers who become unemployed are worse off than they would be with no minimum wage. The minimum wage imposes an unfair rule because it blocks voluntary exchange. Even if firms are willing to hire more labor at a wage that people are willing to take, they are not permitted to do so by the minimum wage law. Explain why a minimum wage is inefficient. A competitive labor market allowed to reach its equilibrium creates an efficient allocation of resources. At the equilibrium: The supply of labor measures the marginal social cost of labor to workers (leisure forgone). The demand for labor measures the marginal social benefit from labor (value of goods produced). A minimum wage set above the equilibrium wage rate creates a surplus of labor—the quantity of labor supplied exceeds the quantity of labor demanded. The minimum wage reduces employment so that it is less than the efficient amount. Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek Third: Taxes Define Tax Incidence: Tax Incidence is the division of the burden of a tax between buyers and sellers. The tax incidence depicts the distribution of the tax obligations, which must be covered by the buyer and seller. When an item is taxed, its price might rise by the full amount of the tax, by a lesser amount, or not at all. 2. If the market price rises by 1. If the market price rises 3. If the market price a lesser amount than the tax, by the full amount of the does not rise at all, sellers buyers and sellers share the tax, buyers pay the tax. pay the tax. burden of the tax. Equivalence of a Tax on Buyers and Sellers. 1. A Tax on Sellers. 2. A Tax on Buyers. Imposing a tax on sellers, decreases supply…Why? Imposing a tax on buyers, decreases demand…Why? Because the tax is like a cost that sellers must pay. The Because the tax lowers the amount they are willing to supply curve shifts leftward. pay to the sellers. The price paid by buyers rises, the price received by The demand curve shifts leftward. sellers falls, and the quantity decreases. Tax Incidence of Elasticity of Demand. The Division of the Tax Between Buyers and Sellers Depends on the Elasticities of Demand. How does the elasticity of demand influence the incidence of a tax, the tax revenue? The more elastic the demand, the smaller the increase in the price paid by the buyers and the greater the decrease in the price received by the sellers, which means that the incidence on buyers is smaller. The more elastic the demand, the smaller the quantity bought so the smaller the tax revenue 1. perfectly Inelastic Demand: 2. Perfectly Elastic Demand. When the tax is imposed on this good, buyers pay the entire When the tax is imposed on this good, sellers pay the entire tax. tax. The Demand curve is vertical. The Demand curve is horizontal. The less elastic the demand, the larger the tax burden paid The more elastic the demand, the smaller the tax burden by the buyers (and the smaller the tax burden paid by the paid by the buyers (and the larger the tax burden paid by sellers). the sellers). For Example: products include luxury goods, houses, and clothing. Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek For Example: the price of Insulin. Consumer will buy it no matter what the price is. The seller will shift all the tax burden on the consumer. Tax Incidence of Elasticity of Supply. The more elastic the supply, the larger the buyers' share of the tax. Labor has a low elasticity of supply, so the seller—the worker—pays most of the income tax and most of the Social Security tax. How does the elasticity of supply influence the incidence of a tax, the quantity bought, the tax revenue? The more elastic the supply for a given demand the larger the increase in the price paid by the buyers and the smaller the decrease in the price received by the sellers, which means that the incidence on buyers is larger. The more elastic the supply, the smaller the quantity bought so the smaller the tax revenue. 1. Perfectly In-Elastic Supply: 2. Perfectly Elastic Supply. When a Tax is imposed, sellers pay the entire tax. When a tax is imposed, buyers pay the entire tax. The Supply of this good is Perfectly In-Elastic. The Supply of this good is Perfectly Elastic. The Supply curve is vertical. The Supply curve is horizontal. Multiple Choice Questions. 1. What does the graph above show? a. Shortage. b. Surplus. c. Supply table. d. Equilibrium. Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek 2. If the price floor was set at $320, what quantity would be purchased? a. 20. b. 40. c. 60. d. 80. 3. A price floor that is set above equilibrium, resulting in: a. A shortage. b. A surplus. c. Limited choice. d. None of the above. 4. Price ceilings lead to………….and price floors lead to…………. a. Surplus; shortage. b. Shortage; surplus. 5. What is the supply with a price floor of $60? a. 50. b. 100. Economics. Section.6 Dr. Gamal Haikal Ms. Shada Tarek c. 150. d. 200. 6. What is the result of the government implementing a price floor of $60? a. There would be a shortage of 100 since it is cheaper for consumers b. There would be a surplus of 100 because it is more expensive for consumers c. There would be a shortage of 100 because it is assisting the suppliers d. There would be a surplus of 100 because it is beneficial to consumers. 7. A price ceiling of $20 would benefit………….. a. Consumers. b. Suppliers. c. Both. d. None of the above. Question.2 The figure above shows the demand for and the supply of rental housing in Township. 1. What are the equilibrium rent and equilibrium quantity of rental housing? The equilibrium rent is $300 a month and the equilibrium quantity is 30,000 housing units. 2. If a rent ceiling is set at $150 a month, what is a. The quantity of housing rented? The quantity rented is 10,000 housing units. The quantity of housing rented is equal to the quantity supplied at the rent ceiling. b. The shortage of housing? The shortage of housing is 40,000 housing units. At the rent ceiling, the quantity of housing demanded is 50,000, but the quantity supplied is 10,000, so there is a shortage of 40,000 housing units.