ECONOMICS
Twelfth Edition, Global Edition
Chapter 6
Government
Actions in Markets
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Chapter Outline and Learning Objectives
6.1 Explain how rent ceilings create
housing shortages. Explain the
influences on demand
6.2 Explain how minimum wage
laws create unemployment
6.3 Explain the effects of a tax
6.4 Explain the effects of production
quotas and subsidies
6.5 Explain how markets for illegal
goods work
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A Housing Market with a Rent Ceiling
(1 of 10)
• A price ceiling （最高限价） or price cap is a regulation that
makes it illegal to charge a price higher than a specified
level.
• When a price ceiling is applied to a housing market it is
called a rent ceiling.
• If the rent ceiling is set above the equilibrium rent, it has no
effect. The market works as if there were no ceiling.
• But a rent ceiling set below the equilibrium rent creates
‒ A housing shortage
‒ Increased search activity
‒ A black market
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A Housing Market with a Rent Ceiling
(2 of 10)
• Housing Shortage
• Figure 6.1 shows the
effects of a rent ceiling
that is set below the
equilibrium rent.
• The equilibrium rent is
$1,000 a month.
• A rent ceiling is set at
$800 a month.
• So the equilibrium rent is
in the illegal region.
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A Housing Market with a Rent Ceiling
(3 of 10)
• At the rent ceiling, the
quantity of housing
demanded exceeds the
quantity supplied.
• There is a shortage of
housing.
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A Housing Market with a Rent Ceiling
(4 of 10)
• Because the legal price
cannot eliminate the
shortage, other
mechanisms operate:
‒ Increased search activity
‒ A black market
• With the shortage,
someone is willing to pay
up to $1,200 a month.
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A Housing Market with a Rent Ceiling
(5 of 10)
• Increased Search Activity
‒ The time spent looking for someone with whom to do business
is called search activity.
‒ When a price is regulated and there is a shortage, search
activity increases.
‒ Search activity is costly and the opportunity cost of housing
equals its rent (regulated) plus the opportunity cost of the
search activity (unregulated).
‒ Because the quantity of housing is less than the quantity in an
unregulated market, the opportunity cost of housing exceeds
the unregulated rent.
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A Housing Market with a Rent Ceiling
(6 of 10)
• A Black Market
‒ A black market is an illegal market that operates alongside a
legal market in which a price ceiling or other restriction has
been imposed.
‒ A shortage of housing creates a black market in housing.
‒ Illegal arrangements are made between renters and landlords
at rents above the rent ceiling—and generally above what the
rent would have been in an unregulated market.
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A Housing Market with a Rent Ceiling
(7 of 10)
• Inefficiency of a Rent Ceiling
‒ A rent ceiling set below the equilibrium rent leads to an
inefficient underproduction of housing services.
‒ The marginal social benefit from housing services exceeds its
marginal social cost and a deadweight loss arises.
‒ Figure 6.2 illustrates this inefficiency.
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A Housing Market with a Rent Ceiling
(8 of 10)
• A rent ceiling decreases
the quantity of housing
supplied to less than the
efficient quantity.
• A deadweight loss arises.
• Producer surplus shrinks.
• Consumer surplus
shrinks.
• There is a potential loss
from increased search
activity.
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A Housing Market with a Rent Ceiling
(9 of 10)
• Are Rent Ceilings Fair?
• According to the fair rules view, a rent ceiling is unfair
because it blocks voluntary exchange.
• According to the fair results view, a rent ceiling is unfair
because it does not generally benefit the poor.
• A rent ceiling decreases the quantity of housing and the
scarce housing is allocated by
‒ Lottery
‒ First-come, first-served
‒ Discrimination
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A Housing Market with a Rent Ceiling
(10 of 10)
• A lottery gives scarce housing to the lucky.
• A first-come, first served gives scarce housing to those who
have the greatest foresight and get their names on the list
first.
• Discrimination gives scarce housing to friends, family
members, or those of the selected race or sex.
• None of these methods leads to a fair outcome.
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A Labor Market with a Minimum Wage
(1 of 7)
• 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.
• If the minimum wage is set below the equilibrium wage rate, it
has no effect. The market works as if there were no minimum
wage.
• If the minimum wage is set above the equilibrium wage rate, it
has powerful effects.
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A Labor Market with a Minimum Wage
(2 of 7)
• Minimum Wage Brings Unemployment
− If the minimum wage is set above the equilibrium wage rate, the
quantity of labor supplied by workers exceeds the quantity demanded
by employers.
− There is a 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.
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A Labor Market with a Minimum Wage
(3 of 7)
• The equilibrium wage rate is $6
an hour.
• The minimum wage rate is set
at $7 an hour.
• So the equilibrium wage rate is
in the illegal region.
• The quantity of labor employed
is the quantity demanded.
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A Labor Market with a Minimum Wage
(4 of 7)
• The quantity of labor supplied
exceeds the quantity demanded
and unemployment is created.
• With only 20 million hours
demanded, some workers are
willing to supply the last hour
demanded for $5.
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A Labor Market with a Minimum Wage
(5 of 7)
• Is the Minimum Wage Fair?
‒ A minimum wage rate in the United States is set by the federal
government’s Fair Labor Standards Act.
‒ In 2009, the federal minimum wage rate was raised to $7.25 an hour
and has remained at $7.25 an hour through 2014.
‒ Some state governments have set minimum wages above the federal
minimum wage rate.
‒ Most economists believe that minimum wage laws increase the
unemployment rate of low-skilled younger workers.
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A Labor Market with a Minimum Wage
(6 of 7)
• Inefficiency of a Minimum Wage
‒ A minimum wage leads to an inefficient outcome.
‒ The quantity of labor employed is less than the efficient quantity.
‒ 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).
‒ Figure 6.4 illustrates this inefficient outcome.
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A Labor Market with a Minimum Wage
(7 of 7)
• A minimum wage set above the
equilibrium wage decreases the
quantity of labor employed.
• A deadweight loss arises.
• The potential loss from
increased job search decreases
both workers’ surplus and firms’
surplus.
• The full loss is the sum of the
red and gray areas.
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Taxes (1 of 21)
• Everything you earn and most things you buy are taxed.
• Who really pays these taxes?
• Income tax and the Social Security tax are deducted from
your pay, and state sales tax is added to the price of the
things you buy, so isn’t it obvious that you pay these taxes?
• Isn’t it equally obvious that your employer pays the
employer’s contribution to the Social Security tax?
• You’re going to discover that it isn’t obvious who pays a tax
and that lawmakers don’t decide who will pay!
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Taxes (2 of 21)
• Tax Incidence （纳税负担）
‒ Tax incidence is the division of the burden of a tax between buyers
and sellers.
‒ When an item is taxed, its price might rise by the full amount of the
tax, by a lesser amount, or not at all.
‒ If the price rises by the full amount of the tax,
‒ buyers pay the tax.
‒ If the price rises by a lesser amount than the tax,
‒ buyers and sellers share the burden of the tax.
‒ If the price doesn’t rise at all,
‒ sellers pay the tax.
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Taxes (3 of 21)
• Tax incidence doesn’t depend on tax law!
• The law might impose a tax on buyers or sellers, but the
outcome will be the same.
• To see why, we look at the tax on cigarettes in New York City.
• On July 1, 2002, New York City raised the tax on the sales of
cigarettes from almost nothing to $1.50 a pack.
• What are the effects of this tax?
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Taxes (4 of 21)
• A Tax on Sellers
• Figure 6.5 shows the effects
of this tax.
• With no tax, the equilibrium
price is $3.00 a pack.
• A tax on sellers of $1.50 a
pack is introduced.
• Supply decreases and the
curve S + tax on sellers
shows the new supply
curve.
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Taxes (5 of 21)
• The market price paid by
buyers rises to $4.00 a
pack and the quantity
bought decreases.
• The price received by the
sellers falls to $2.50 a
pack.
• So with the tax of $1.50 a
pack, buyers pay $1.00 a
pack more and sellers
receive 50¢ a pack less.
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Taxes (6 of 21)
• A Tax on Buyers
• Again, with no tax, the
equilibrium price is $3.00
a pack.
• A tax on buyers of $1.50 a
pack is introduced.
• Demand decreases and
the curve D tax on
buyers shows the new
demand curve.
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Taxes (7 of 21)
• The price received by
sellers falls to $2.50 a
pack and the quantity
decreases.
• The price paid by buyers
rises to $4.00 a pack.
• So with the tax of $1.50 a
pack, buyers pay $1.00 a
pack more and sellers
receive 50¢ a pack less.
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Taxes (8 of 21)
• Equivalence of Tax on
Buyers and Sellers
• So, exactly as before
when sellers were taxed:
• Buyers pay $1.00 of the
tax.
• Sellers pay the other 50¢
of the tax.
• Tax incidence is the same
regardless of whether the
law says sellers pay or
buyers pay.
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Taxes (9 of 21)
• Tax Incidence and Elasticity of Demand
‒ The division of the tax between buyers and sellers depends
on the elasticities of demand and supply.
‒ To see how, we look at two extreme cases.
Perfectly inelastic demand: Buyers pay the entire tax.
Perfectly elastic demand: Sellers pay the entire tax.
‒ The more inelastic the demand, the larger is the buyers’ share
of the tax.
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Taxes (10 of 21)
• Perfectly Inelastic
Demand
• Demand for this good is
perfectly inelastic—the
demand curve is vertical.
• When a tax is imposed on
this good, buyers pay the
entire tax.
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Taxes (11 of 21)
• Perfectly Elastic
Demand
• The demand for this good
is perfectly elastic—the
demand curve is
horizontal.
• When a tax is imposed on
this good, sellers pay the
entire tax.
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Taxes (12 of 21)
• Tax Incidence and Elasticity of Supply
‒ To see the effect of the elasticity of supply on the division of
the tax payment, we again look at two extreme cases.
Perfectly inelastic supply: Sellers pay the entire tax.
Perfectly elastic supply: Buyers pay the entire tax.
‒ The more elastic the supply, the larger is the buyers’ share of
the tax.
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Taxes (13 of 21)
• Perfectly Inelastic
Supply
• The supply of this good is
perfectly inelastic—the
supply curve is vertical.
• When a tax is imposed on
this good, sellers pay the
entire tax.
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Taxes (14 of 21)
• Perfectly Elastic Supply
• The supply of this good is
perfectly elastic—the
supply curve is horizontal.
• When a tax is imposed on
this good, buyers pay the
entire tax.
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Taxes (15 of 21)
• Taxes in Practice
‒ Taxes usually are levied on goods and services with an
inelastic demand or an inelastic supply.
‒ Alcohol, tobacco, and gasoline have inelastic demand, so the
buyers of these items pay most of the tax on them.
‒ 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.
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Taxes (16 of 21)
• Taxes and Efficiency
‒ Except in the extreme cases of perfectly inelastic demand or
perfectly inelastic supply when the quantity remains the same,
imposing a tax creates inefficiency.
‒ Figure 6.10 shows the inefficiency created by a $20 tax on
MP3 players.
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Taxes (17 of 21)
• With no tax, marginal
social benefit equals
marginal social cost.
• Total surplus (the sum of
consumer surplus and
producer surplus) is
maximized.
• The market is efficient.
• The tax decreases the
quantity, raises the
buyers’ price, and lowers
the sellers’ price.
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Taxes (18 of 21)
• Marginal social benefit
exceeds marginal social
cost and the tax is
inefficient.
• The tax revenue takes
part of the total surplus.
• The decreased quantity
creates a deadweight
loss.
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Taxes (19 of 21)
• Taxes and Fairness
‒ Economists propose two conflicting principles of fairness to
apply to a tax system:
The benefits principle
The ability-to-pay principle
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Taxes (20 of 21)
• The Benefits Principle
‒ The benefits principle is the proposition that people should pay
taxes equal to the benefits they receive from the services
provided by government.
‒ This arrangement is fair because it means that those who
benefit most pay the most taxes.
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Taxes (21 of 21)
• The Ability-to-Pay Principle
‒ The ability-to-pay principle is the proposition that people
should pay taxes according to how easily they can bear the
burden of the tax.
‒ A rich person can more easily bear the burden than a poor
person can.
‒ So the ability-to-pay principle can reinforce the benefits
principle to justify high rates of income tax on high incomes.
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Production Quotas and Subsidies (1 of 6)
• Intervention in markets for farm products takes two main
forms:
‒ Production quotas
‒ Subsidies
• A production quota is an upper limit to the quantity of a
good that may be produced during a specified period.
• A subsidy is a payment made by the government to a
producer.
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• A production quota set below the equilibrium
quantity has the following effects:
– a decrease in supply
– a rise in price
– a decrease in marginal cost
– inefficient underproduction
– an incentive to cheat and overproduce
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Production Quotas and Subsidies (2 of 6)
• Production Quotas
• With no quota, the price is
$30 a ton and 60 million
tons a year are produced.
• With the production quota
of 40 million tons a year,
quantity decreases to
40 million tons a year.
• The market price rises to
$50 a ton and marginal
cost falls to $20 a ton.
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Production Quotas and Subsidies (3 of 6)
• Inefficiency
• At the quantity produced:
‒ Marginal social benefit
equals the market price,
which has increased.
‒ Marginal social cost has
decreased.
• Production is inefficient
and producers have an
incentive to cheat.
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Production Quotas and Subsidies (4 of 6)
• Subsidies
• With no subsidy, the price
is $40 a ton and 40 million
tons a year are produced.
• With a subsidy of $20 a
ton, marginal cost minus
subsidy falls by $20 a ton
and the new supply curve
is S – subsidy.
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Production Quotas and Subsidies (5 of 6)
• The market price falls to
$30 a ton and farmers
increase the quantity to
60 million tons a year.
• But farmers’ marginal cost
increases to $50 a ton.
• With the subsidy, farmers
receive more on each ton
sold—the price of $30 a
ton plus the subsidy of $20
a ton, which is $50 a ton.
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Production Quotas and Subsidies (6 of 6)
• Inefficient
Overproduction
• At the quantity produced:
‒ Marginal social benefit
equals the market price,
which has fallen.
‒ Marginal social cost has
increased and exceeds
marginal social benefit.
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Markets for Illegal Goods (1 of 8)
• The U.S. government prohibits trade of some goods,
such as illegal drugs.
• Yet, markets exist for illegal goods and services.
• How does the market for an illegal good work?
• To see how the market for an illegal good works, we
begin by looking at a free market and see the changes
that occur when the good is made illegal.
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Markets for Illegal Goods (2 of 8)
• A Free Market for a Drug
• Figure 6.13 shows the
market for a drug such as
marijuana.
• Market equilibrium is at
point E.
• The price is PC and the
quantity is QC.
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Markets for Illegal Goods (3 of 8)
• Penalties on Sellers
• If the penalty on the seller
is the amount HK, then the
quantity supplied at a
market price of PC is QP.
• Supply of the drug
decreases to S + CBL.
• The new equilibrium is at
point F. The price rises and
the quantity decreases.
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Markets for Illegal Goods (4 of 8)
• Penalties on Buyers
• If the penalty on the buyer
is the amount JH, the
quantity demanded at a
market price of PC is QP.
• Demand for the drug
decreases to D – CBL.
• The new equilibrium is at
point G. The market price
falls and the quantity
decreases.
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Markets for Illegal Goods (5 of 8)
• But the opportunity cost of
buying this illegal good
rises above PC because
• the buyer pays the market
price plus the cost of
breaking the law.
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Markets for Illegal Goods (6 of 8)
• Penalties on Both Sellers
and Buyers
• With both sellers and
buyers penalized for trading
in the illegal drug, …
• both the demand for the
drug and the supply of the
drug decrease.
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Markets for Illegal Goods (7 of 8)
• The new equilibrium is at
point H.
• The quantity decreases to
QP.
• The market price is PC.
• The buyer pays PB and the
seller receives PS.
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Markets for Illegal Goods (8 of 8)
• Legalizing and Taxing Drugs
‒ An illegal good can be legalized and taxed.
‒ A high enough tax rate would decrease consumption to the
level that occurs when trade is illegal.
‒ Arguments that extend beyond economics surround this
choice.
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