2. Price Ceilings
A price ceiling is a legal restriction on the
price of the product. In particular, it is a
legal maximum price. Suppose that the
maximum price for a bottle of milk was
1.000.000 TL. This means that any price
from 1.000.001TL or higher is illegal, and
any price of 1.000.000 TL or lower is legal.
4. • What is the equilibrium price for ice cream? ($3)
• What happens if a price ceiling of $2.00 per cone
is put in effect?
• It will cause a shortage of ice cream cones equal to
50 units. Why? Because at $2.00 per cone,
quantity demanded equals 125 while quantity
supplied is only 75.
5. Effects of Price Ceilings
• Shortages - The most common result of effective
price ceilings is the fact that quantity demanded
exceeds quantity supplied - therefore, a shortage
develops in the marketplace.
• Rationing of Scarce Goods - Because products
with price ceilings tend to be in short supply,
rationing becomes an issue. Normally, free
markets simply allocate goods to those most
willing to pay for them, and everybody who is
willing to pay the market price or higher for a
good tends to get it. With shortages, the allocation
of the product can be arbitrary, inefficient and
even unfair.
6. Effects of Price Ceilings
• Wasted Time - Another consequence of
market shortages is that buyers tend to have
to wait in long lines to get the product. The
time wasted in line is a negative effect.
7. Price Floors
A price floor is a legal restriction on the
price of the product. In particular, it is a
legal minimum price. Suppose that the
minimum price for a bottle of milk was
1.000.000 TL. This means that any price
from 1.000.001 TL or higher is legal, and
any price of 1.000.000TL or lower is
illegal.
8. Effects of Price Floors
• Surpluses - The most common consequence of an
effective price floor is that the market tends to
experience a surplus of the product since a binding
price floor holds the market price above the
equilibrium price. This high price induces more
output by sellers, and less demand from
consumers.
• Rationing Among Sellers - Since there is a
surplus of the product, there is rationing among
sellers that is inefficient and often unfair, just like
the rationing among buyers that occurred with a
price ceiling.
9. Taxes
• Taxes on Buyers - When buyers are taxed
by the government, we depict this as a
downward shift in the demand curve.
• Taxes on Sellers - When the government
collects the tax from sellers (like with sales
tax), we depict this as an upward shift in the
supply curve.
10. Tax Incidence
Tax Incidence is the study of who bears
the burden of taxes.
The interaction of price elasticity of
demand and price elasticity of supply
determine whether the sellers or the buyers
bear the greater burden .
11. When demand is relatively inelastic,
quantity demanded will NOT fall by a
large amount. Therefore, buyers
continue to purchase the product after
the tax is imposed and this causes them
to pay a larger share of the tax.
When demand is relatively ELASTIC
consumers greatly reduce their
purchases of the product. Since
consumers buy a lot smaller quantity
after the tax is imposed, they avoid
paying the tax - therefore, sellers pay a
larger portion of the tax.
