Quick Summary

• Market outcomes are driven by supply and demand, with equilibrium prices and quantities.
• Governments intervene through price controls, taxes, and subsidies to address perceived market inefficiencies.
• Price ceilings prevent prices from rising above a limit, potentially causing shortages.
• Price floors set minimum prices, possibly leading to surpluses.
• Taxes shift supply or demand, creating tax wedges, affecting market activity, and generating deadweight losses.
• Subsidies boost supply or demand, potentially causing overproduction and fiscal costs.
• Deadweight loss arises from market distortions and depends on elasticities of supply and demand.
• Tax incidence depends on relative elasticities and determines who bears the economic burden.
• Tax systems balance efficiency (costs, administrative burden) and equity (fair distribution).
• Principles such as benefit-based and ability-to-pay guide tax fairness considerations.

Concepts and Definitions

• Market equilibrium: The point where supply equals demand.
• Price control: Government regulation of maximum (ceiling) or minimum (floor) prices.
• Price ceiling: A maximum allowable price set below equilibrium, leading to shortages.
• Price floor: A minimum price set above equilibrium, leading to surpluses.
• Tax incidence: Distribution of tax burden between buyers and sellers.
• Deadweight loss: Loss in total economic welfare caused by market distortions.
• Subsidy: Government payment that lowers costs or increases income for producers or consumers.
• Elasticity: Response of quantity demanded or supplied to price changes.
• Tax system principles:
  • Fairness (equity)
  • Efficiency
  • Certainty
  • Convenience

Formulas, Laws, Principles

• Tax Revenue: $ \text{Tax} = \text{Tax Rate} \times \text{Taxable Base} $
• Deadweight Loss of Tax:
  $$ DWL = \frac{1}{2} \times \text{Tax} \times \text{Reduction in Quantity} $$
• Tax Incidence:
  Distribution depends on demand elasticity and supply elasticity; less elastic side bears more burden.
• Laffer Curve: Demonstrates the relationship between tax rate and total tax revenue, indicating an optimal tax rate.

Methods and Procedures

1. Analyze market equilibrium to identify shortage/surplus conditions.
2. Implement price controls:
   • Set ceiling below equilibrium to create shortages.
   • Set floor above equilibrium to cause surpluses.
3. Apply taxes:
   • Determine whether a specific or ad valorem tax.
   • Shift supply or demand curves accordingly.
   • Calculate tax incidence based on elasticities.
4. Design subsidies:
   • Shifting supply outward to lower prices and increase quantities.
   • Consider fiscal costs and market distortions.
5. Estimate deadweight loss using elasticities and quantity reductions.
6. Ensure tax fairness following principles such as benefits or ability-to-pay.

Illustrative Examples

1. Rent control (price ceiling): Sets maximum rent, causing shortages in available housing.
2. Minimum wage law (price floor): Sets a minimum wage above equilibrium, leading to unemployment.
3. Tax on petrol: Raises market price, shifts supply curve, and affects consumers, producers, and government revenue.

Pitfalls and Points of Attention

• Confusing binding vs. non-binding price controls.
• Overlooking elasticities when assessing tax incidence and deadweight loss.
• Assuming taxes always shift burden onto the government or consumers—burden shares depend on elasticities.
• Misestimating fiscal costs of subsidies versus market benefits.
• Ignoring administrative costs and fairness principles in designing tax systems.

Glossary

• Market equilibrium: Balance point where quantity supplied equals quantity demanded.
• Price ceiling: Legal maximum price, often leading to shortages.
• Price floor: Legal minimum price, often causing surpluses.
• Tax incidence: Distribution of tax burden.
• Deadweight loss: Welfare loss due to market distortion.
• Elasticity: Measure of responsiveness of quantity to price change.
• Subsidy: Financial support from government.
• Laffer Curve: Relationship between tax rates and revenue.
• Tax progressivity: How tax burden changes with income.
• Vertical equity: Fairness based on ability to pay.
• Horizontal equity: Equal treatment of equals in taxation.