Price control
What is a price ceiling? Give one example from real life.
A legal maximum price for a product
real life example: rent control
What is a tax? Give one example of a common tax people pay.
- a mandatory payment people or businesses make to the government
Example: Sales tax paid when buying goods or income tax paid on earnings.
What is a subsidy? Give one example.
- a financial aid on a certain product provided by the government
- example: governmental aid on the production of electrical cars/ farm
What is a negative externality? Give one example
- when a person/ a business' actions cause negative effects to bystanders
- eg. pollution
what are the shifters of supply?
Explain how a price floor can lead to a surplus in the market.
A price floor is the minimum price allowed by law. If it is set above the equilibrium price, producers will supply more because the price is higher, but consumers will buy less because it’s more expensive. This mismatch causes a surplus, meaning extra goods are left unsold.
Example: Minimum wage laws can create a surplus of labor (unemployment).
What is the main purpose of taxes in an economy?
- raise government revenue
- correct market activities
Why do governments give subsidies to certain industries?
- support production of a certain good/ service
- make prices lower for consumers/ producers
- support certain jobs or industries
Why do negative externalities cause market failure?
- the true cost (social optimum) is often higher than the market equilibrium
- overproduction/ over-consumption of harmful goods
- inefficient -> market failure
what are the factors of production?
land, labor, capital, entrepreneurship
A government sets a price ceiling below the equilibrium price for bread. What will likely happen to the quantity demanded and supplied?
- will cause a shortage of bread
If the government places a tax on sugary drinks, how will this affect the market for those drinks?
- cost of production increases -> price increases
- price increases -> quantity demanded decreases
- deadweight loss appears
- government revenue formed
How does a subsidy affect the supply curve in a market?
- decreases production cost
- supply curve shifts towards the right (downwards)
What can the government do to reduce negative externalities?
- regulations
- corrective taxes and subsidies
- tradable pollution permits
what is the opportunity cost?
the cost of the second best alternative
Compare and contrast price ceilings and price floors in terms of their effects on consumers and producers. Provide an example for each.
Price ceilings - keep prices low, usually more beneficial to consumers (eg. rent control, more affordable housing provided to consumers but because of this producers earn less money from rent)
Price floors - keep prices high, might hurt consumers because of the surplus (eg. unemployment, workers are unable to find jobs because the demand for labor is lower than the supply)
Using a supply and demand diagram, explain how the burden of a tax (tax incidence) is shared between consumers and producers. What determines who pays more?
the original equilibrium determines the allocation of tax
If the government gives a subsidy to electric car manufacturers, what will likely happen to the price and quantity of electric cars?
- the price of electric cars will decrease and the quantity sold will increase (supply curve shifts to the right)
- because the government pays part of it
Draw or explain a supply and demand diagram showing the impact of a negative externality. Label the social cost and the market equilibrium.
- The MPC lies below the MSC
- The market equilibrium occurs where MPC = Marginal benefits
The socially optimal quantity is smaller, where marginal benefits = marginal social cost.
why do people make decisions in the society?
resources are limited but wants are infinite
Suppose the equilibrium price for milk is $4 per liter. The government sets a price floor of $5 per liter. Using a labeled supply and demand diagram, explain step by step how this policy affects the market for milk, including changes to consumer surplus, producer surplus, and deadweight loss.
1. The price floor of $5 is above equilibrium, so it is binding.
2. At $5, quantity supplied > quantity demanded, creating a surplus of milk.
3. Consumers buy less milk (consumer surplus decreases).
4. Producers sell less overall (even though the price is higher, total profit may fall due to unsold goods).
5. Deadweight loss appears
How does the PED and PES effect the deadweight loss?
- more inelastic: smaller dwl
- more elastic: larger dwl
Using a supply and demand diagram, explain how a subsidy affects consumer surplus, producer surplus, and government spending.
- shifts supply curve to the right (shifts downwards)
- consumer surplus increases because consumers pay less for the good
- producer surplus increases because they pay less to produce the goods
- government spending increases
A factory emits pollution that harms nearby farms. The government imposes a tax equal to the external cost per unit of output. Using economic reasoning, explain how this tax can lead to a more efficient market outcome.
(diagram)
the tax might not be equal to the external cost (wedge between MSC and MPC)
it can still reduce the deadweight loss -> more efficient
what does a point on the PPF show?
it means that this combination is effective and possible