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LESSON 9
Government Intervention
Assigned Reading
1.
Mankiw, N. Gregory, et al. 2011. Principles of Microeconomics (5th Canadian Edition). Toronto:
Thomson Nelson.
Chapter 6: Supply, Demand, and Government Policies
Recommended Reading
1.
Mankiw, N. Gregory, et al. 2011. Study Guide to Accompany Principles of Microeconomics
(5th Canadian Edition). Toronto: Thomson Nelson.
Chapter 6: Supply, Demand, and Government Policies
Learning Objectives
After studying this lesson, students should be able to:
1.
Examine the effects of government policies that place a ceiling on prices.
2.
Examine the effects of government policies that place a floor under prices.
3.
Consider how a tax on a good affects market equilibrium price and quantity.
4.
Recognize the equivalence of taxes imposed on buyers and sellers.
5.
Explain how the burden of a tax is divided between buyers and sellers.
Instructor's Comments
Price floors and ceilings are one broad class of government intervention into markets addressed in this
lesson. One thing economists are virtually unanimous about is that rent control is a lousy way to provide
affordable housing for the poor. The text lays out quite clearly the short-run and long-run consequences of
rent control. In particular, because landlords have a lower incentive to maintain units, the quality of the
housing stock deteriorates more quickly and buildings that are demolished are not replaced by rental
buildings, but by condominium buildings. With excess demand and a cap on rents, landlords find other ways
to allocate units, often choosing to rent to higher income tenants. Once in a rent-control unit, tenants have
little incentive to leave even as their income rises. The long-run result is a smaller, lower quality stock,
where the rent control units are hard to find and often occupied by higher income renters. It is not surprising
that economists are close to unanimous in their assessment that rent control is a very poor way to provide
affordable housing for poor renters.
9.1
Lesson 9
The second major class of intervention is the fees and taxes government places on goods and services. One
of the important economics issues with a tax is the question of incidence: who bears the burden of the tax?
(i.e., who really pays the tax?) The answer to this question depends on the relative elasticities of supply and
demand. When a local government raises the property tax, who ends up paying the tax: renters or property
owners? While the property tax is levied on building value, for the sake of convenience, let us assume that
we can think of it as a tax per housing unit. What would happen to rents paid by tenants? What would
happen to the after-tax net income of landlords? The landlord writes the cheque, but the effect is to shift the
supply curve up the amount equal to the tax. The more inelastic supply is relative to demand, the greater the
share of the tax paid by landlords. We believe that in the short-run, the supply of real estate is quite
inelastic. Therefore, in the short-run most of the burden should fall on landlords. In the long-run, the supply
is substantially more elastic. Demand is more elastic in the long-run as well, but the change is not as
dramatic as it is for supply. Thus, in the long-run some of the burden shifts away from landlords and back to
tenants. The "new view" of property tax incidence is that landlords bear the principal burden.
Review and Discussion Questions
1.
Suppose that next year crude oil prices skyrocket because of a crisis in the middle East. As a result,
gasoline prices rise by 50%. Parliament caves in to political pressure and places a six-month price
ceiling on gasoline at the previous year's level.
(a)
What will be the effect on quantity demanded of rolling back gasoline prices? Explain how
this could happen.
(b)
What will be the effect on quantity supplied of rolling back gasoline prices? Explain.
(c)
What will be the overall effect of this price ceiling?
The next FIVE (5) questions use the following information:
The Market for Widgets
2.
9.2
Price
QD
QS
QSʹ
QDʹ
$1.00
$1.50
$2.00
$2.50
$3.00
$3.50
$4.00
$4.50
$5.00
1,000
900
800
700
600
500
400
300
200
0
100
200
300
400
500
600
700
800
0
0
0
100
200
300
400
500
600
800
700
600
500
400
300
200
100
0
What are the initial equilibrium price and quantity?
Government Intervention
3.
4.
5
Suppose that the provincial government imposes a new $1.00 per unit tax on the sellers of widgets.
The tax shifts the supply schedule from the original QS to the new QSʹ.
(a)
What is the new equilibrium price and quantity?
(b)
How much of the $1.00 tax is borne by the seller?
(c)
How much of the tax is born by the buyer?
(d)
Show graphically the old and new equilibria, labelling the original supply as S and the new
supply as S1. Label clearly the vertical shift in supply and the change in price and quantity
as a result of the tax.
Ms. Malak, a provincial MLA in whose riding several widget factories are located, has proposed a
new piece of legislation that would change the widget tax. Her bill would switch the tax from the
seller to the buyer, under the rationale that the widget makers are losing money and cannot afford to
pay the tax. If the bill passes the legislature, quantities supplied will change back from QSʹ to QS,
and quantities demanded will change from QD to QDʹ.
(a)
What is new equilibrium price and quantity?
(b)
How much of the $1.00 tax is borne by the seller?
(c)
How much of the tax is born by the buyer?
(d)
Did the new legislation help the sellers? Why or why not?
(e)
Show graphically the original (pretax) and the new equilibria, labelling the original demand
as D and the new demand as D1. Label clearly the vertical shift in demand and the change
in price and quantity as a result of the tax.
The legislature has voted to abolish the widget tax, so price and quantity have returned to the
original equilibrium. To help the widget makers in her province, Ms. Malak has proposed
legislation that would enact a price floor of $4.00 in the market for widgets.
(a)
As a result of her legislation, the price will be $
, quantity supplied will be QS =
quantity demanded will be QD =
, and there will be a [shortage/surplus/neither] of
The actual quantity sold will be
.
,
.
(b)
Who is helped and who is hurt by the price floors?
(c)
If the price floor had been enacted while the $1.00 tax on sellers was already in effect, what
would have happened to price and quantity? Would there have been a shortage or a surplus?
9.3
Lesson 9
6.
Suppose that pressure from consumer groups leads to a reduction in the price floor from $4.00 to
$3.00.
(a)
With the new price floor (and no tax), the price will be $
=
, and the quantity demanded will be QD =
.
, quantity supplied will be QS
(b)
What is the effect of the new price floor at $3.00? Explain.
(c)
Show graphically the effects of a price floor of $4.00 and $3.00, labelling clearly the
equilibrium price and quantity and any shortages or surpluses that result in each case. Label
the $4.00 price floor as PF1 and the $3.00 price floor as PF2.
7.
Participants at a recent economics seminar in Vancouver pointed out to the speaker that there is a
basic flaw in the logic of microeconomics, which is built upon the concept of scarcity. They
observed that housing is not really scarce in Vancouver, even though a very modest apartment can
rent for well over $1,000 per month. According to these critics, it is simply landlords' greed that
prevents everyone from having affordable housing. They provided statistics showing that the
numbers of dwellings and the number of families were roughly equal, which they felt provided
proof that there is not a scarcity of housing. Consequently, they argued for rent controls as a
solution to the housing crisis in Vancouver. What's wrong with this way of thinking? Is it valid to
argue that a scarcity does not exist just by counting the number of houses? Are houses freely
available at a zero price? Suppose that rent controls forced the rent on a $1,000 apartment down to
$100. What would happen to new construction? To maintenance on existing apartments? What
would happen to the quantity demanded? Write an economist's response to these critics of
mainstream economics.
8.
Who benefits from a binding price ceiling? Who is hurt by a binding price ceiling?
9.
How do the effects of rent control differ in the short-run and the long-run?
10.
Who benefits from a binding price floor? Who is hurt by a binding price floor?
11.
Why are economists nearly always opposed to price controls?
12.
What alternative methods of helping the less fortunate might be better than rent control and
minimum wage laws?
13.
One economist called rent control "the best way to destroy a city, other than bombing". What do
you think he meant by that?
14.
What are the advantages of rent subsidies and wage subsidies as alternatives to rent control and
minimum wage laws? Are these alternatives costless to society?
15.
Lovers of classical music persuade Parliament to impose a price ceiling of $40 per ticket. Does this
policy get more or fewer people to attend classical music concerts?
16.
If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more
than $500, less that $500, or exactly $500? Explain.
9.4
Government Intervention
17.
Consider the following policies, each of which is aimed at reducing violent crime by reducing the
use of guns. Illustrate each of these proposed policies in a supply-and-demand diagram of the gun
market.
(a)
(b)
(c)
(d)
18.
A tax on gun buyers
A tax on gun sellers
A price floor on guns
A tax on ammunition
A subsidy is the opposite of a tax. With a $0.50 tax on the buyers of ice-cream cones, the
government collects $0.50 for each cone purchased; with a $0.50 subsidy for the buyers of icecream cones, the government pays buyers $0.50 for each cone purchased.
(a)
(b)
Show the effect of a $0.50 per cone subsidy on the demand curve for ice-cream cones, the
effective price paid by consumers, the effective price received by sellers, and the quantity
of cones sold.
Do consumers gain or lose from this policy? Do producers gain or lose? Does the
government gain or lose?
9.5
Lesson 9
ASSIGNMENT 9
CHAPTER 6: Supply, Demand, and Government Policies
Marks: 1 mark for each question.
1.
In general, the intention of price controls is to:
(1)
(2)
(3)
(4)
2.
An effective minimum wage law can be expected to:
(1)
(2)
(3)
(4)
3.
clear the market for blue-collar workers.
increase employment for some affected workers.
increase the number of firms in those industries where the law is effective.
cause unemployment for some unskilled workers.
Under what circumstances will the consumers of a good end up paying the full amount of a tax?
(1)
(2)
(3)
(4)
4.
help the financially disadvantaged.
keep inflation low.
prevent suppliers from gaining monopoly power.
All of the above
Supply is perfectly inelastic and demand is not.
Demand is perfectly inelastic and supply is not.
Demand is more elastic than supply.
Demand is less elastic than supply.
Under what circumstances will the consumers of a good end up paying a larger share of a tax than
suppliers will?
(1)
(2)
(3)
(4)
Demand is more elastic than supply.
Demand is less elastic than supply.
Demand is perfectly elastic and supply is not.
Supply is perfectly inelastic and demand is not.
Assignment 9 continues on the next page
9.6
Government Intervention
5.
How did the presence of price ceilings during the 1970s gas crisis impact Canada and the United States?
A.
B.
C.
D.
(1)
(2)
(3)
(4)
6.
(2)
(3)
(4)
with shortages and waiting lists, they have no incentive to maintain and improve their
property.
they know they can never please their tenants.
the law no longer requires them to maintain their buildings.
they see it as a way of protesting against the controls.
Which of the following is accurate?
(1)
(2)
(3)
(4)
9.
an efficient and equitable way to help the poor.
not efficient, but the best way to solve a serious social problem.
a highly inefficient way to help the poor raise their standard of living.
an efficient way to allocate housing, but not a good way to help the poor.
Under rent control, landlords cease to be responsive to tenants' concerns about the quality of the
housing because:
(1)
8.
Only B is true
A and C
B and D
A, C, and D
Economists generally hold that rent control is:
(1)
(2)
(3)
(4)
7.
Since Canada had no price ceilings, when the supply of gas decreased, a new equilibrium
price was found where the demand curve and the new supply curve intersected.
Canada had no price ceilings, but the reason there wasn't a shortage of gas is because
Canadians significantly decreased their demand of gas when the supply of gas decreased.
Since the US had a price ceiling, when the supply of gas decreased, the quantity demanded
at the ceiling price was much larger than the quantity supplied by the producers.
Since the US had a price ceiling, a gas shortage was created and gas stations often had
long lines.
An effective minimum wage raises the incomes of all workers.
An effective minimum wage lowers the incomes of all workers.
An effective minimum wage raises the incomes of those workers who have jobs, and lowers
the incomes of those workers who cannot find jobs.
An effective minimum wage has no effect on the incomes of workers.
Unlike rent control, rent subsidies:
(1)
(2)
(3)
(4)
do not make housing more affordable for poor people.
do not lead to housing shortages.
do not require the government to make payments.
are illegal.
Assignment 9 continues on the next page
9.7
Lesson 9
10.
The demand for cigarettes is highly inelastic. As a result, a tax imposed on buyers of cigarettes will:
(1)
(2)
(3)
(4)
11.
If a tax is imposed on a market with inelastic demand and elastic supply, then:
(1)
(2)
(3)
(4)
12.
sellers will bear most of the burden of the tax.
buyers will bear most of the burden of the tax.
the burden of the tax will be shared equally between buyers and sellers.
it is impossible to determine how the burden of the tax will be shared.
A binding price floor will create:
(1)
(2)
(3)
(4)
13.
have a large impact on the consumption of cigarettes.
be mainly borne by sellers of cigarettes.
be equally shared by sellers and consumers of cigarettes.
be mainly borne by the consumers of cigarettes.
prices lower than equilibrium.
an excess of supply
quantity demanded higher than equilibrium quantity.
a shortage of supply.
A tax of $0.10 per bag on the sellers of popcorn will cause:
(1)
(2)
(3)
(4)
the price the buyers pay and the effective price the sellers receive to rise.
the price the buyers pay and the effective price the sellers receive to fall.
the price the buyers pay to rise, and the effective price the sellers receive to fall.
the price the buyers pay to fall, and the price the sellers receive to rise.
Assignment 9 continues on the next page
9.8
Government Intervention
The next TWO (2) questions use the following information:
14.
Which panel best represents a binding rent control in the short-run?
(1)
(2)
(3)
(4)
15.
In which of the panels is the effect of rent control felt primarily in a reduction in the rental price?
(1)
(2)
(3)
(4)
16.
Panel (a)
Panel (b)
Panel (c)
None of the panels
Panel (a)
Panel (b)
Panel (c)
Panels (a) and (b)
Which of the following is a mechanism of rationing used by landlords in cities with rent control?
(1)
(2)
(3)
(4)
Waiting lists
Racial preferences
Making rental accommodation "adult only"
All of the above
Assignment 9 continues on the next page
9.9
Lesson 9
17.
Who bears the burden of a payroll tax?
(1)
(2)
(3)
(4)
18.
How does imposing a tax affect the equilibrium quantity in an industry?
(1)
(2)
(3)
(4)
19.
they have a great concern for social well-being.
desirable apartments command higher prices.
they are forced to do so by law.
there is always a surplus of housing.
Which is an accurate statement about price controls?
(1)
(2)
(3)
(4)
___
20
The equilibrium quantity increases
The equilibrium quantity decreases
There is no change in the equilibrium quantity
The equilibrium quantity may increase or decrease, depending on the elasticity of the supply
and demand curves
In free markets, landlords try to keep their buildings clean and safe because:
(1)
(2)
(3)
(4)
20.
The employer bears the entire burden.
The employee bears the entire burden.
The employer always bears 58% of the burden and the employee always bears 42% of the burden.
It depends on the forces of supply and demand.
Price controls are usually enacted when policymakers believe that the market price of a
good or service is unfair to buyers or sellers.
Price controls are used to make markets more efficient.
Price controls are nearly always effective in eliminating inequities.
All of the above
Total Marks
Planning Ahead
You should continue to think about your plans for Project 2 and should be
doing as much work as you can well in advance for this project. Do not
leave this until the last minute, or you will scrambling at the due date and
will likely not be pleased with the work you submit.
End of Assignment 9
9.10