Supply Demand And Government Policies

Examine the effects of government policies that place a ceiling on prices

Examine the effects of government policies that put a floor under prices

Consider how a tax on a good affects the price of the good and the quantity sold

Economists have two roles. As scientists, they develop and test theories to explain the world around them. As policy advisers, they use their theories to help change the world for the better. The focus of the preceding two chapters has been scientific. We have seen how supply and demand determine the price of a good and the quantity of the good sold. We have also seen how various events shift supply and demand and thereby change the equilibrium price and quantity.

This chapter offers our first look at policy. Here we analyze various types of government policy using only the tools of supply and demand. As you will see, the analysis yields some surprising insights. Policies often have effects that their architects did not intend or anticipate.

We begin by considering policies that directly control prices. For example, rent-control laws dictate a maximum rent that landlords may charge tenants. Minimumwage laws dictate the lowest wage that firms may pay workers. Price controls are

Learn that taxes levied on buyers and taxes levied on sellers are equivalent

See how the burden of a tax is split between buyers and sellers usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers. Yet, as we will see, these policies can generate inequities of their own.

After our discussion of price controls, we next consider the impact of taxes. Policymakers use taxes both to influence market outcomes and to raise revenue for public purposes. Although the prevalence of taxes in our economy is obvious, their effects are not. For example, when the government levies a tax on the amount that firms pay their workers, do the firms or the workers bear the burden of the tax? The answer is not at all clear—until we apply the powerful tools of supply and demand.

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