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Chapter

5: Government Interven1on
The Cost of Interfering with
Market Forces

Playconomics, LHS

A. Price Ceiling
Deni1on:
The Price Ceiling represents a maximum
allowable price imposed by the government.

when Gov. believes that P is unfairly high
(to protect low-income consumers)
Playconomics, LHS

A. Price Ceiling
Say Pmarket = $100 and Pceiling = $80

If Pmarket < Pceiling ! policy has no eect !!


Playconomics, LHS

A. Price Ceiling
Deni1on:
The Deadweight Loss is the loss in economic

surplus due to the market being prevented


from reaching the equilibrium price and
quanOty where marginal benet (MB)
equals marginal cost (MC).

Playconomics, LHS

A. Price Ceiling
The winners of this policy are the consumers
with high reservaOon price (i.e., high willingness
to pay)
!!
Solu1on: If the government wanted to help the
low-income households, a

is more ecient.

Playconomics, LHS

B. Price Floor
Deni1on:
The Price Floor represents a minimum allowable
price imposed by the government.

when Gov. believes that P is unfairly low
(to protect producers in a certain sector)
Playconomics, LHS

B. Price Floor
Say Pmarket = $100 and Poor = $120

If Pmarket > Poor ! policy has no eect !!


Playconomics, LHS

B. Price Floor
The losers of this policy are all those harmed by
the price oor
!!
Solu1on: The losers would be willing to pay the
winners the exact amount they gained from the
intervenOon in exchange for cancelling the price
oor

Playconomics, LHS

C. TaxaOon
Unlike the price ceiling and the price oor, a
tax

Tax revenues can be used to
within a society

improves the distribuOon of Income & OpportuniOes


across dierent populaOon groups
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C. TaxaOon
Say we tax producers

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C. TaxaOon
Say we tax producers (Who bears the tax burden?)

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C. TaxaOon
The losers of this policy are
the
(P, Q ) or
the
(if D = inelasOc OR S = perfectly elasOc)
the
(if S = inelasOc OR D = perfectly elasOc)
The winner is the

gets tax revenue

Solu1on: The losers would be willing to pay the


winner the exact amount it gained from the
intervenOon in exchange for cancelling the tax

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C. TaxaOon
The winner is
use tax revenue to
subsidize or reduce taxes on other markets
provide public goods, etc.

Tax those with the lowest elas1city!!


Why? The more elasOc supply & demand are at the


iniOal P*, the bigger the deadweight loss!
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C. TaxaOon

If Gov. needs to impose a $1 tax, the most eec1ve way of


doing it is to apply it to the least elas1c market!
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D. Subsidy
Opposite of a tax
Government
to assist certain groups of
consumers (or producers)

makes certain goods more aordable for certain


groups of consumers
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D. Subsidy
Say we subsidize producers

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D. Subsidy
The winners of this policy are the consumers and
producers, but it costs more to the Government
then it benets the people.
Solu1on: If the government wanted to make
certain goods more aordable, a

is more ecient.

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Summary: Government IntervenOon


converge to an
equilibrium where

Any
that prevents a market
from reaching its P* is


Gov. intervenOon at all cost!

Some1mes this is not true: Public Goods!


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