Chapter 6: Prices, Price Controls, and Quantity Regulations – Government Intervention in Markets

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Prices, Price Controls, and Quantity Regulations

Introduction to Government Intervention in Markets

In a free market, the forces of supply and demand determine the equilibrium price and quantity of goods and services. However, governments often intervene in markets to influence outcomes, typically through policies such as taxes, subsidies, price controls, and quantity regulations. These interventions do not eliminate supply and demand but alter the costs and benefits faced by market participants, thereby changing their decisions.

Government intervention can affect wages, prices, and the allocation of resources.
Policies may target public health, income distribution, or market efficiency.
Examples include minimum wage laws, taxes on goods, and subsidies for child care.

How Taxes and Subsidies Change Market Outcomes

Definition and Effects of Taxes

A tax is a compulsory financial charge imposed by a government on goods, services, income, or activities. Taxes can be levied on buyers or sellers and affect both the price paid by consumers and the price received by producers.

Statutory burden: The party legally responsible for paying the tax to the government.
Economic burden (tax incidence): The actual distribution of the tax's cost between buyers and sellers, determined by changes in prices and quantities.
Example: A tax on sugar-sweetened beverages raises the price for consumers and reduces sales and revenue for sellers.

Tax Incidence: Who Bears the Burden?

The tax incidence refers to how the burden of a tax is shared between buyers and sellers. The division depends on the relative price elasticities of supply and demand.

If demand is more inelastic than supply, buyers bear a larger share of the tax.
If supply is more inelastic than demand, sellers bear a larger share of the tax.
The statutory assignment (who sends the tax to the government) does not determine the economic burden.

Helpful Hint: The more inelastic your curve, the more of the tax burden you will bear.

Example: Soda Tax

Suppose a $0.20 tax is imposed on soda.
If buyers are relatively inelastic, they may pay $0.15 of the tax (75%), while sellers pay $0.05 (25%).
If sellers are relatively inelastic, the burden shifts toward them.

Formula for Tax Incidence:

Buyer’s share:
Seller’s share:

Subsidies

A subsidy is a payment made by the government to buyers or sellers to encourage consumption or production of a good. Subsidies have the opposite effect of taxes, increasing quantities bought and sold and lowering prices for consumers (or raising prices received by sellers).

Example: A $5,000 subsidy for electric car purchases increases demand and quantity sold.
The benefit of a subsidy is also divided according to the relative elasticities of supply and demand.

Price Regulations

Price Ceilings

A price ceiling is a maximum price that sellers are allowed to charge for a good or service, set by the government. Binding price ceilings are set below the market equilibrium price and can lead to shortages.

Example: A price ceiling on cancer drugs at $6,000 per dose when equilibrium price is higher leads to excess demand and a shortage.
Consequences include reduced supply, discouraged investment, and rationing.

Price Floors

A price floor is a minimum price that sellers are allowed to charge, set above the equilibrium price. Binding price floors lead to surpluses.

Example: Minimum wage laws set a floor for labor prices, increasing wages for low-income workers but potentially causing unemployment.
Scotland’s minimum price for alcohol ($1.50 per can) led to a surplus of beer.

Helpful Hint: Ceilings go below equilibrium price; floors go above.

Quantity Regulations

Quotas and Mandates

Quantity regulations restrict the amount of a good that can be bought or sold. These include quotas (maximum quantity) and mandates (minimum quantity).

Quota: Limits the maximum quantity that can be sold (e.g., taxi medallions, one-child policy in China).
Mandate: Requires a minimum quantity to be bought or sold (e.g., health insurance mandates).
Binding quotas are set below equilibrium quantity, causing reduced sales and higher prices.
Binding mandates are set above equilibrium quantity, causing increased sales and lower prices.

Analyzing Market Outcomes Under Regulation

Determine if the regulation is binding (i.e., set above or below equilibrium).
For price controls: Find the regulated price and corresponding quantity supplied and demanded.
For quantity controls: Find the regulated quantity and the price at which it is supplied/demanded.
Calculate any resulting surplus or shortage.

Summary Table: Types of Market Regulation

Type	Definition	Effect on Market	Binding Condition
Tax	Compulsory payment to government	Decreases quantity, increases price for buyers, decreases price for sellers	Any positive tax
Subsidy	Government payment to buyers/sellers	Increases quantity, decreases price for buyers, increases price for sellers	Any positive subsidy
Price Ceiling	Maximum legal price	Shortage if below equilibrium	Set below equilibrium price
Price Floor	Minimum legal price	Surplus if above equilibrium	Set above equilibrium price
Quota	Maximum legal quantity	Reduces quantity sold, raises price	Set below equilibrium quantity
Mandate	Minimum legal quantity	Increases quantity sold, lowers price	Set above equilibrium quantity

Key Takeaways

The statutory burden determines which curve shifts (supply or demand), but not who bears the economic burden.
Economic burden (tax incidence) is determined by the relative price elasticities of supply and demand.
Price controls and quantity regulations only affect market outcomes if they are binding.
Always compare pre- and post-policy equilibrium to assess the impact.

Additional info: Academic context and examples have been expanded for clarity and completeness. All equations are provided in LaTeX format as required.