DEMAND & SUPPLY IN

ACTION
CH.6

Price Ceilings
A price ceiling is a legal restriction on the
price of the product. In particular, it is a
legal maximum price. Suppose that the
maximum price for a bottle of milk was
1.000.000 TL. This means that any price
from 1.000.001TL or higher is illegal, and
any price of 1.000.000 TL or lower is legal.

Table #1
Demand & Supply for Ice
Cream
P
Q
Q
D

$2.00

125

75

$2.25

120

80

$2.50

110

85

$2.75

105

95

$3.00

100

100

$3.25

95

110

$3.50

90

115

$3.75

85

120

$4.00

80

125

 What is the equilibrium price for ice cream? ($3)

What happens if a price ceiling of $2.00 per cone is put in effect?
It will cause a shortage of ice cream cones equal to 50 units.
Why? Because at $2.00 per cone, quantity demanded equals 125
while quantity supplied is only 75.

Effects of Price Ceilings

Shortages - The most common result of effective price
ceilings is the fact that quantity demanded exceeds
quantity supplied - therefore, a shortage develops in the
marketplace.
Rationing of Scarce Goods - Because products with
price ceilings tend to be in short supply, rationing
becomes an issue. Normally, free markets simply
allocate goods to those most willing to pay for them, and
everybody who is willing to pay the market price or
higher for a good tends to get it. With shortages, the
allocation of the product can be arbitrary, inefficient and
even unfair.

Effects of Price Ceilings

Wasted Time - Another consequence of
market shortages is that buyers tend to have
to wait in long lines to get the product. The
time wasted in line is a negative effect.

Price Floors
A price floor is a legal restriction on the
price of the product. In particular, it is a
legal minimum price. Suppose that the
minimum price for a bottle of milk was
1.000.000 TL. This means that any price
from 1.000.001 TL or higher is legal, and
any price of 1.000.000TL or lower is illegal.

Effects of Price Floors

Surpluses - The most common consequence of an
effective price floor is that the market tends to
experience a surplus of the product since a binding
price floor holds the market price above the
equilibrium price. This high price induces more
output by sellers, and less demand from consumers.
Rationing Among Sellers - Since there is a surplus
of the product, there is rationing among sellers that
is inefficient and often unfair, just like the rationing
among buyers that occurred with a price ceiling.

Taxes
Taxes on Buyers - When buyers are taxed
by the government, we depict this as a
downward shift in the demand curve.
Taxes on Sellers - When the government
collects the tax from sellers (like with sales
tax), we depict this as an upward shift in the
supply curve.

Tax Incidence
Tax Incidence is the study of who bears the
burden of taxes.
The interaction of price elasticity of
demand and price elasticity of supply
determine whether the sellers or the buyers
bear the greater burden .

When demand is relatively inelastic,

quantity demanded will NOT fall by a
large amount. Therefore, buyers
continue to purchase the product after
the tax is imposed and this causes them
to pay a larger share of the tax.

When demand is relatively ELASTIC

consumers greatly reduce their
purchases of the product. Since
consumers buy a lot smaller quantity
after the tax is imposed, they avoid
paying the tax - therefore, sellers pay a
larger portion of the tax.