ECON1001 · Introductory Microeconomics
Government Intervention: Price Controls & Taxes
Week 10 puts the welfare toolkit to work on policy. A price floor binds when set above P* and creates excess supply (e.g. a minimum wage); a price ceiling binds when set below P* and creates a shortage. Taxes drive a wedge of size t between the price buyers pay and sellers receive, raising government revenue t × Q but causing a deadweight loss from the lost trades. The key result is that economic incidence is independent of legal incidence: who actually bears the tax depends only on relative elasticities — the more inelastic side pays more.
What this chapter covers
- 01Price floors: binding above P*, excess supply, welfare loss
- 02Price ceilings: binding below P*, shortage, non-price rationing
- 03Why controls bind harder in the long run
- 04Per-unit (specific) vs ad valorem taxes
- 05The tax wedge: price paid Pc vs price received Pp
- 06Government revenue = t × Q and deadweight loss from lost trades
- 07Tax incidence: legal vs economic; relative-elasticity rule
- 08Deadweight loss and revenue as functions of tax size (Laffer logic)
Tax incidence and deadweight loss
- 2 marks · original equilibriumNo-tax equilibrium: 40 − Q = 4 + 2Q → 36 = 3Q → Q* = 12, P* = 28.
- 2 marks · taxed quantityTax on producers shifts supply up by 6: P = 4 + 2Q + 6 = 10 + 2Q. New equilibrium: 40 − Q = 10 + 2Q → 30 = 3Q → Q_t = 10.
- 2 marks · Pc and PpBuyers pay Pc = 40 − 10 = 30; sellers receive Pp = 30 − 6 = 24.
- 2 marks · incidence split and reasoningIncidence: buyers bear 30 − 28 = 2; sellers bear 28 − 24 = 4. Sellers bear more because supply is more inelastic (steeper) here.
- 2 marks · revenue and DWLGovernment revenue = t × Q_t = 6 × 10 = 60. Deadweight loss = ½ × t × (Q* − Q_t) = ½ × 6 × (12 − 10) = 6.
Key terms
- Binding price floor
- A legal minimum price set above the equilibrium price; it creates excess supply (quantity supplied exceeds quantity demanded) and reduces total surplus.
- Binding price ceiling
- A legal maximum price set below the equilibrium price; it creates a shortage that must be rationed by queues, discrimination or side payments, lowering total surplus.
- Per-unit (specific) tax
- A fixed amount of tax charged per unit traded, which shifts the relevant curve vertically by the tax amount; contrasts with an ad valorem (percentage) tax.
- Tax wedge
- The gap of size t that a tax opens between the price buyers pay and the price sellers receive at the new, lower traded quantity.
- Tax incidence
- The division of a tax's burden between buyers and sellers; economic incidence depends only on relative elasticities, not on who legally remits the tax.
- Deadweight loss from a tax
- The surplus lost on the mutually beneficial trades that no longer occur because the tax reduces quantity from Q* to Q_t; it grows with the tax size.
Government Intervention: Price Controls & Taxes FAQ
Does it matter whether a tax is levied on buyers or sellers?
Not for the economic outcome. Whether the tax is legally on buyers or sellers, the equilibrium quantity, the prices each side effectively faces, the revenue and the deadweight loss are identical. Only the relative elasticities determine who really bears the burden.
Who bears more of a tax?
The more inelastic side of the market. If demand is more inelastic than supply, buyers bear most of the tax because they respond little to the higher price; if supply is more inelastic, sellers bear most. Equal elasticities split it evenly.
Why do price controls do more damage over time?
Because both demand and supply become more elastic in the long run as participants adjust. A binding ceiling or floor that causes a small shortage or surplus initially produces a much larger one as quantities respond more fully, magnifying the welfare loss.
Exam move
Run every policy question through the same welfare lens you built in the equilibrium chapter: find the original equilibrium, impose the control or tax, then compare quantities, prices and surplus. For taxes, master the wedge: shift one curve by t, solve for Q_t, read Pc off demand and Pp off supply, then split incidence by slope. Lock in the two headline results — legal incidence is irrelevant, and revenue rises then falls with tax size while deadweight loss rises throughout — because they are reliable exam multiple-choice fodder.
