Lecture Notes: Government Controls on the Economy

Introduction

• Presenter: Jacob Reed
• Topics: Government controls, price floors, price ceilings, taxes, subsidies, and quantity controls
• Additional Resources: Total review booklet available at revieweecon.com

Purpose of Government Controls

• Price Floors: Reduce poverty, provide living wage for low-skilled workers (e.g., minimum wage)
• Price Ceilings: Make housing more affordable (e.g., rent control)
• Taxes: Provide revenue for the government
• Subsidies: Incentivize businesses to produce items
• Quantity Controls: Regulate specific amounts of production within a market

Impact on Competitive Markets

• Competitive markets at equilibrium are allocatively efficient and maximize economic surplus
• Government controls create inefficiency and deadweight loss
• In units 5 and 6, learn about government interventions that can increase efficiency in cases of monopoly power, monopsony power, or externalities

Quantity Controls

• Government establishes specific production amounts
• Underproduction: Mandated quantity (QC) less than equilibrium quantity (QE) leads to deadweight loss
• Overproduction: Mandated quantity higher than QE also leads to deadweight loss

Price Floors

• Definition: Minimum price for a product (e.g., minimum wage)
• Impact: Must be above equilibrium price to be binding
  • Results in quantity supplied (Qs) > quantity demanded (Qd) → surplus
  • Surplus remains as prices cannot fall
  • Creates deadweight loss
• Elasticity Impact: Inelastic supply/demand curves result in smaller surplus; elastic curves result in larger surplus
• Removal: Price falls to equilibrium, increasing consumer surplus and eliminating deadweight loss

Price Ceilings

• Definition: Maximum price for a product (e.g., rent control)
• Impact: Must be below equilibrium price to be binding
  • Results in quantity demanded (Qd) > quantity supplied (Qs) → shortage
  • Only Qs will be sold
  • Creates deadweight loss
• Removal: Price rises to equilibrium, reducing quantity demanded, increasing quantity supplied, and eliminating deadweight loss

Taxes and Subsidies

• Subsidies: Payment to producers/consumers per unit of product
  • Shifts supply curve vertically by subsidy amount
  • Causes overproduction and deadweight loss
  • Government expenditure = Per unit subsidy x Quantity sold
• Taxes: Levy on production/consumption per unit
  • Shifts supply curve left by tax amount
  • Causes underproduction and deadweight loss
  • Tax revenue = Per unit tax x Quantity sold

Tax Incidence (Tax Burden)

• Determining Burden: Split between consumers and producers
  • Consumer Burden: Difference between post-tax price (PB) and equilibrium price (PE)
  • Producer Burden: Difference between PE and post-tax price sellers receive (PS)
• Elasticity Impact:
  • Less elastic (more inelastic) curve bears more tax burden
  • Perfectly elastic curve bears no tax burden
  • Perfectly inelastic curve bears all tax burden

Conclusion

• Summary of government controls and their impacts
• Further assistance: Review booklet available at revieweecon.com
• End of lecture