Summary: Main Points on

Price Controls and Taxes


PowerPoint Presentation here

Click here for ANSWERS TO SELECTED QUESTIONS IN THE TEXT
 

MAXIMUM LEGAL PRICES
Here is the key diagram for a maximum legal price -- one type of price control.
(We will always consider maximum legal prices below the equilibrium price [because].

The maximum legal price:

The shortage means that some form of rationing will determine which people can buy goods (and how much each person can buy).  Types of rationing include EXAMPLES
 
 

APPLICATION:

MINIMUM LEGAL PRICES
Here is the key diagram for a minimum legal price -- another type of price control. (We will always consider minimum legal prices above the equilibrium price [because].The minimum legal price: EXAMPLES
 
 
 
 
 
 
 
 
 
 
 
 
 

TAXES

Here is the key diagram for analyzing a tax. 

A tax on sales or production of a good creates a gap or tax wedge between the price that buyers pay, including tax, and the price that sellers receive, net of tax.  The difference is the per-unit tax.   [EXAMPLE]

[WHICH PRICE IS THE PRICE TAG ON THE GOOD AT THE STORE?]

[WHAT IF THE GOVERNMENT SAYS SELLERS MUST PAY THE TAX?]

[WHAT IF THE GOVERNMENT SAYS BUYERS MUST PAY THE TAX?]
 

SOME KEY POINTS:
A tax raises the price to buyers, lowers the price to sellers, and lowers the quantity bought and sold.
 [BECAUSE]        [EXAMPLE]

Buyers and sellers share the tax payment since buyers pay more than they would pay without the tax and sellers receive less (net of tax).

The analysis of a tax does NOT depend on who is legally responsible for paying the tax to the government, so neither buyers or sellers care who must legally pay the tax.  (That is, neither the price buyers pay, nor the price sellers receive, depends on the law.)

A tax reduces output because the gains from some trades are smaller than the tax that people would have to pay if they made those trades.
 
 

TAX RATES AND TAX PAYMENTS
A higher tax rate usually means higher tax payments (and government tax revenue).  But a higher tax rate can  result in lower tax payments (and government revenue) if the higher tax rate reduces the equilibrium quantity sufficiently.  This is the point of the Laffer Curve.  (See pages 195-196 in the text.)  Be prepared to show this point by duplicating a graph like the one on page 196.
 
SPECIAL CASES OF ELASTICITIES
With perfectly inelastic demand, a tax With perfectly inelastic supply, a tax With perfectly elastic demand, a tax With perfectly elastic supply, a tax See graphs on page 194.
 [BECAUSE]        [EXAMPLE]
 
 
SUBSIDIES
Subsidies work like negative taxes. Subsidizing sales or production of a good lowers the price that buyers pay (net of the subsidy), raises the price that sellers receive (including the subsidy), and raises the quantity bought and sold. The government pays the cost of the subsidy, and buyers and sellers share the benefits of the subsidy. Neither the price buyers pay or the price sellers receive depends on which group (buyers or sellers) gets the subsidy, so it does not matter whether the government subsidizes buyers or sellers.  See the graph on page 197.  Be prepared to draw one like it.
 
 

Copyright, Alan C. Stockman

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