Taxes, Prices 1.

How Taxes and Subsidies Change

Market Outcomes
Controls, and
Quantity 2. Price Regulations

Regulations 3. Quantity Regulations

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 • Would you do this job less
than min wage?
• Min wage is not determined by
supply and demand.
• Employers are prohibited
from hiring anyone at a lower
page even if you would be
willing to for less.

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 Government Intervention in Markets
Yes, supply and demand determine the quantity and price at which goods are sold, but the government can
influence this market outcome through laws, regulations, and taxes.

Examples:
Minimum wage may determine how much you get paid.
Taxes impact your take-home pay, or the price you pay when buying something.
Government policy can influence the costs and benefits of getting married and/or having children.

Government does not stop the forces of supply and demand, rather…
shapes costs and benefits, thus changing the decisions that sellers and buyers make.

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 Government Intervention in Markets

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Assess how taxes shape supply, 1. How Taxes and Subsidies Change
demand, and equilibrium Market Outcomes
outcomes
2. Price Regulations
Understand how subsidies
shape equilibrium outcomes 3. Quantity Regulations

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 Soda Tax
Sugary drinks are a major contributor to common health
risks like diabetes, heart disease, and more. Many countries,
including the United States, have put a tax on
sugar-sweetened beverages (a soda tax) to drive up the
price so that people will drink fewer of them.
The soda tax affects both buyers and sellers:
drives up the prices of soda for consumers
drives down sales and prices received by soda sellers.
Why is there a difference between the price buyers pay and
the price sellers receive?
Because the government takes a cut in the form of a
tax.

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 A Tax on Sellers A Tax on Buyers
Soda Tax Example: Soda Tax Example:
In 2017, Philadelphia introduced a tax on sellers Suppose, instead, the government imposed
of sweetened beverages of 1.5 cents per ounce. the tax on buyers.
When you buy a 20-ounce soda, you pay
The way this works:
whatever price the seller posted. But the seller
does not keep that entire posted amount for stores post the price without the tax
themselves.
sellers keep this entire posted amount
The seller keeps whatever the consumer
paid minus the tax.
you pay the tax as you check out

they are responsible for sending the tax consumer pay = posted price + tax
to the government: the store does you the convenience of
$0.015 per ounce × 20 ounces = $0.30 mailing in the tax.

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 Key Definition (1 of 5) Diving into the Definition

Statutory burden: The burden of being Soda Tax Example:

assigned by the government to send a If sellers of sweetened beverages are subject
tax payment. to a tax of 1.5 cents per ounce, then the
statutory burden falls on the sellers.
Economic burden: The burden created
by the change in the after-tax prices However, the economic burden is more
nuanced.
faced by buyers and sellers.
Perhaps the seller was able to push some of
Tax incidence: The division of the that tax burden onto the consumers in the
economic burden of a tax between form of a price increase.
buyers and sellers. If so, then sellers didn’t really bear the
entire tax burden alone.
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 Who really pays the tax? Elasticity is what matters!

Spoiler: The tax incidence does NOT The tax incidence is determined by the relative
depend on the statutory burden. elasticities of the market’s supply and demand
curves.
The economic burden of a tax levied on HELPFUL HINT: The more inelastic your
sellers may or may not fully fall upon curve, the more of the tax burden you will
sellers. bear:
The economic burden of a tax levied on If sellers are relatively more inelastic, then
consumers may or may not fully fall sellers will ultimately pay more of the tax.
upon consumers.
If buyers are relatively more inelastic,
Take-away: You cannot simply look at the then buyers will ultimately pay more of
tax policy as written to determine the the tax.
economic burden of a tax.
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 Road map: Assessing the impact of a tax
Big Picture Goal: Demonstrate the equivalence of a tax on buyers and sellers.

Main Take-away: It doesn’t matter whether the government puts the tax on the
buyers or the sellers; the end result is exactly the same!

The Plan:
1. Assess the impact of a $0.30 tax placed on sellers.
2. Assess the impact of a $0.30 tax placed on buyers.
3. Compare market outcomes (should be identical!).

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 Assessing the impact of a tax on sellers (1 of 3)
The government imposes a $0.30 tax on sellers. Price of soda
($ per bottle)
This $0.30 tax on sellers is seen as a rise in the New supply
marginal costs of production.
Recall: The supply curve is the marginal cost curve
$0.30 shift up
if marginal costs are $0.30 higher…
Supply
then the supply curve must shift $0.30 up.*
*Typically, we describe a decrease in supply as a leftward shift, $1.10 Equilibrium without tax
but “up” tends to be more intuitive in tax scenarios.

To get the new supply curve, we adjust each

(price, quantity) pair on the original supply curve to Demand
now account for the tax: (price + tax, quantity) Quantity of soda
1.4 (millions of bottles per week)

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 Assessing the impact of a tax on sellers (2 of 3)
The new equilibrium is found where the demand
Price of soda
and new supply curves intersect. ($ per bottle)
New supply
The quantity of soda purchased falls from 1.4
to 1.2 million bottles per week. Equilibrium
with tax
The new price buyers pay is NOT the same as the
new price sellers receive: $1.30
Supply
New Price Buyers Pay is $1.30.
$1.10 Equilibrium without tax
$0.20 up from original $1.10 price
$1.00
New Price Sellers Receive is $1.00.
$0.10 down from original $1.10 price Demand
The two prices are different because the Quantity of soda
1.2 1.4 (millions of bottles per week)
government takes a $0.30 cut from every sale.
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 Assessing the impact of a tax on sellers (3 of 3)
Both buyers and sellers bear the economic
Price of soda
burden of the tax (even though the statutory burden ($ per bottle)
was only on sellers). New supply
Buyers now pay $0.20 more per soda because Equilibrium
of the tax. with tax
Buyers are paying $0.20 of the $0.30 tax in $1.30
Supply
the form of a price increase.
Tax incidence on buyers is 2/3, or 66.7%. $1.10 Equilibrium without tax
Sellers now receive $0.10 less per soda because $1.00
of the tax.
Demand
Sellers are paying $0.10 of the $0.30 tax.
Quantity of soda
Tax incidence on sellers is 1/3, or 33.3%. 1.2 1.4 (millions of bottles per week)

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 Assessing the impact of a tax on buyers (1 of 3)
The government imposes a $0.30 tax on buyers.
Price of soda
This $0.30 tax on buyers reduces the marginal ($ per bottle)
benefits of buying a soda by $0.30.
Recall: The demand curve is the marginal benefit
curve
if marginal benefits are $0.30 lower… $0.30 shift down Supply
then the demand curve must shift $0.30 down.*
$1.10 Equilibrium without tax
*Typically, we describe a decrease in demand as a leftward shift, but
“down” tends to be more intuitive in tax scenarios.
Demand
To get the new demand curve, we adjust each (price,
New demand
quantity) pair on the original demand curve to now
Quantity of soda
account for the tax: (price - tax, quantity) 1.4 (millions of bottles per week)

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 Assessing the impact of a tax on buyers (2 of 3)
The new equilibrium is found where the demand
Price of soda
and new supply curves intersect. ($ per bottle)
The quantity of soda purchased falls from 1.4
to 1.2 million bottles per week.
The new price buyers pay is NOT the same as the
new price sellers receive: $1.30
Supply
New Price Sellers Receive is $1.00. Equilibrium
$1.10 with tax Equilibrium without tax
$0.10 down from original $1.10 price
$1.00
New Price Buyers Pay is $1.30. Demand
$0.20 up from original $1.10 price New demand
The two prices are different because the 1.2 1.4
Quantity of soda
(millions of bottles per week)
government takes a $0.30 cut from every sale.
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 Assessing the impact of a tax on buyers (3 of 3)
Both buyers and sellers bear the economic Price of soda
burden of the tax (even though the statutory burden was ($ per bottle)
only on buyers).

Buyers now pay $0.20 more per soda because of

the tax.
Buyers are paying $0.20 of the $0.30 tax in $1.30
Supply
the form of a price increase.
Equilibrium
Tax incidence on buyers is 2/3, or 66.7%. $1.10 with tax Equilibrium without tax
Sellers now receive $0.10 less per soda because of $1.00
the tax. Demand
New demand
Sellers are paying $0.10 of the $0.30 tax.
Quantity of soda
1.2 1.4 (millions of bottles per week)
Tax incidence on sellers is 1/3, or 33.3%.
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 Discussing Results Elasticity is what matters!
The tax incidence does NOT depend on
The tax incidence is determined by the relative
the wording of the tax policy as set by the price elasticities of supply and demand.
government.
• More inelastic 🡪 more of the tax burden
In both scenarios, the $0.30 tax was In this example, demand was relatively more
borne by both buyers and sellers: inelastic than supply (visually, the demand
curve is steeper).
The buyers always paid $0.20 of the
Because buyers were relatively less responsive
$0.30 tax in the form of a price rise.
to price changes (i.e., more inelastic), the buyers
ultimately bore more of the tax incidence:
The sellers always paid $0.10 of the
$0.30 tax in that they received $0.10 66.7% (versus 33.3% borne by sellers)
less for every soda sold.

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 Tax incidence depends on price elasticity (1 of 2)
Suppose the same $0.30 tax was imposed on
sellers, but this time demand is even more
inelastic (i.e., even steeper).
Results:
New buyer price rises by $0.25 from $1.10
to $1.35.
Buyers are paying $0.25 of the $0.30 tax
in the form of a price rise.
Buyers’ share of the tax incidence is
now 0.25/0.30 = 83.3%.
Sellers have a small share of the economic
burden, 16.7%, because they are much more
elastic compared to buyers.
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 Tax incidence depends on price elasticity (2 of 2)
Suppose the same $0.30 tax was imposed on
sellers, but this time demand is relatively
elastic (i.e., flatter curve).
Results:
New buyer price rises by $0.05 from $1.10 to
$1.15.
Buyers are paying $0.05 of the $0.30 tax in
the form of a price rise.
Buyers’ share of the tax incidence is
now 0.05/0.30 = 16.7%.
Sellers have a large share of the economic
burden, 83.3%, because they are much more
inelastic compared to buyers.
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 The more inelastic party bears more of the tax burden:

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 Four-step recipe for evaluating taxes

1. Which curve is shifting: supply, demand, or both?

2. Is it an increase or a decrease in taxes?

Increases in tax will shift the curve to the left.
Decreases in tax will shift the curve to the right.

3. Compare the pre-tax and post-tax equilibriums.

4. Who is more inelastic, buyers or sellers (demand or supply)?

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 You Try! Assess the impact of the tax (1 Scenario: Louisiana is considering a new
of 2) tax of $0.10 per gallon of gas. Sellers will
pay this directly to the government. How
Step 1: Which curve is shifting?
does this affect market outcomes?
• ______________ curve shifts.
Price
Step 2: Does the curve shift left or right?

Step 3: Compare pre- and post-tax outcomes.

• Quantity of gas sold ________________. Supply
• New buyer price _______ and new seller price Pold
_________.

Step 4: Who is more inelastic? Demand

• ______________ are more inelastic so they will
bear more of the economic burden. Qold Quantity

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 You Try! Assess the impact of the tax (2 Scenario: Turkey is considering a new tax of
of 2) $0.10 per gallon of gas. Sellers will pay this
Step 1: Which curve is shifting? directly to the government. How does this
affect market outcomes?
• Supply curve shifts.
Step 2: Does the curve shift left or right? Price New supply
• This is a rise in the sellers’ marginal cost, so
the supply curve shifts up to the left.
$0.10 shift up
Step 3: Compare pre- and post-tax outcomes. Pbuyer
Supply
• Quantity of gas sold decreases.
• New buyer price rises and new seller price Pold
falls. Pseller

Step 4: Who is more inelastic? Demand

• Buyers are more inelastic so they will bear
more of the economic burden. Qnew Qold Quantity

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 Key Definition (2 of 5) Diving into the Definition
Example: Pell Grants are a subsidy that the
Subsidy: A payment made by the
government gives lower-income people who
government to those who make a specific
choice. choose to go to college (it does not need to be repaid).

HELPFUL HINT: A subsidy is a negative tax. helps pay for education expenses (tuition,
The subsidy operates just like a tax, but with room & board, other fees, etc.).
the opposite sign.
Impact of Pell Grant:
Subsidies increase the quantities
demanded and supplied (rather than decrease, as It encourages people who may not otherwise
we saw with a tax). attend to college to attend.

Subsidies lower the price to buyers and increases the quantity of education being
increase the price sellers receive (this is the consumed.
opposite of what a tax does to prices).
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 Assessing the impact of a subsidy
Use the same four-step recipe used to analyze a tax:
1. Which curve is shifting? To whom does the policy state the subsidy is granted, demanders or suppliers?
2. Increase or decrease? Did the marginal cost (or marginal benefit) increase or decrease as a result of the
subsidy?
3. How will prices and quantities change in the new equilibrium? Compare the pre- and
post-subsidy outcomes.
4. Is demand or supply relatively more elastic? Who gains the greater benefit of the subsidy?

The economic benefit of the subsidy is determined by the relatively price elasticities of the
demand and supply curves.
The more inelastic party captures more of the benefits of the subsidy.

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 Subsidizing Child Care Policy Proposal: Pay parents of young children a $3,000
subsidy to help manage of the costs of child care.
Step 1: Since the subsidy is given to parents, this will shift Predict the outcome of this policy in the child care market.
the demand curve.
Price of child care
Step 2: The subsidy increases demand by raising (per year per child)
consumers’ marginal benefits (demand shifts right, or “up,” by Equilibrium
$3,000). Supply
with
Step 3: Equilibrium is where the new demand curve subsidy
meets the supply curve.
$12,000
Quantity rises from 13 to 15 million children in child
care.
New demand
Sellers now receive an additional $2,000. $10,000
now receive $12,000 instead of $10,000.
$3,000 shift up
$9,000
Parents now pay $1,000 less.
now pay $9,000 instead of $10,000. Old demand
Step 4: The economic benefit is shared between buyers
and sellers, with sellers capturing relatively more benefits 13 15 Quantity
(millions of children in child care)
(sellers are relatively more inelastic).

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 Key take-aways: Taxes and subsidies
The statutory burden determines which curve shifts (supply or demand),
and whether the curve shifts up or down.
Did the government assign the tax (subsidy) to buyers or sellers?
Just because the tax is “assigned” to that party does not mean that
party bears that tax burden alone.
Statutory burden does not determine the economic burden:
Instead, the tax incidence is determined by the relative price
elasticities of the buyers and sellers.
The more inelastic party bears more of the tax burden.
The more inelastic party captures more of the subsidy benefits.

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Define, illustrate, and analyze 1. How Taxes and Subsidies Change
price ceilings Market Outcomes
2. Price Regulations
Define, illustrate, and analyze
price floors 3. Quantity Regulations

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 Key Definition (3 of 5) Diving into the Definition
Price ceilings: A maximum price that sellers Scenario: The supply-equals-demand
can charge. market equilibrium price is $5, but the
Specifically, it is a maximum price set by the government imposes a price ceiling, which
government. prevents the price from rising above $4.
makes it illegal to exchange goods or Price Supply
services for prices above the established
maximum price. Non-binding
$6
price ceiling
Binding price ceilings: A price ceiling that $5 Market equilibrium
prevents the market from reaching the market Binding
equilibrium price. $4
price ceiling
A binding price ceiling must be set BELOW Demand
the equilibrium price. Quantity
50
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 Price Ceilings and the Housing Market (1 of 2)
When a price ceiling is applied to the housing market, it
Price
is called rent control. (monthly rent)
Suppose the government establishes a maximum Supply
rent of $2,000 per month.
The price ceiling leads to a shortage of apartments:
Suppliers are willing to rent 950,000 apartments
at this price. $3,000 Equilibrium without price ceiling

Consumers demand 1.1 million apartments at this

price. $2,000 Price ceiling

Shortage: 1,100 – 950 = 150 thousand Shortage

apartments. Demand
There are 150,000 people looking for apartments 950 1,000 1,100 Quantity
who can’t find one at this lower price. (thousands of
apartments)
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 Price Ceilings and the Housing Market (2 of 2)
Unintended Consequences of Price Ceiling:
Price
Little to no incentive for landlords to do repairs (monthly rent)
since they can’t charge higher rent for the nicer Supply
place.
Increased potential for biased tenant selection.
Increased tendance for bribes, “finders’ fees,” and
black market formation. $3,000 Equilibrium without price ceiling

Increased search costs (time spent looking for an

apartment). $2,000 Price ceiling

The total cost of the apartment — when you include Shortage

bribes, finders’ fees, and the cost of hassle — rises Demand
above the regulated $2,000 price. Quantity
950 1,000 1,100
(thousands of
apartments)
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 Key Definition (4 of 5) Diving into the Definition
Price floors: A minimum price that sellers can Scenario: The supply-equals-demand market
charge. equilibrium price is $5, but the government
imposes a price floor, which prevents the price
Specifically, it is a minimum price set by the
from falling below $6.
government.
makes it illegal to exchange goods or Price Supply
services for prices below the established
maximum price. $6
Binding
price floor
Binding price floor: A price ceiling that $5 Market equilibrium
prevents the market from reaching the Non-binding
market equilibrium price. $4
price floor
A binding price floor must be set ABOVE the Demand
equilibrium price.
50 Quantity
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 Price floors: When regulation forces higher prices

Reasons the government may want to set a binding price floor:

1. Government wants to raise prices in order to help sellers.
Example: Minimum wage is a price floor that raises the wages received by the
lowest-wage workers. Instead of selling their labor for $5 per hour, the current federal
minimum wage guarantees workers will receive at least $7.25 per hour when they
sell their labor on the labor market.
2. Government wants to reduce the quantity sold in the market.
Example: Many governments set minimum prices for alcohol in order to reduce
alcohol consumption.

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 Scotland’s Price Floor on Alcohol (1 of 2)

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 Scotland’s Price Floor on Alcohol (2 of 2)
Scotland adopted a price floor for alcohol that Price
effectively set a minimum price for a can of beer at ($ per can)
$1.50.
Demand Supply
The price floor leads to a surplus of beer:
$1.50 Price floor
Consumers demand 13 billion cans of beer per
year at this price.
Suppliers are willing to sell 17 billion cans of beer
per year at this price $1.00 Equilibrium without price floor

Surplus: 17 – 13 = 4 billion cans of beer

Producers would be willing to produce and sell up Surplus
to 4 billion more cans of beer per year at this price,
but they are prevented from doing so by the
Quantity
government. 13 15 17
(billions of cans of
beer per year)
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 Key take-aways: Price regulations
Price Ceiling
The maximum price sellers are allowed to charge.
Binding price ceilings go BELOW the market equilibrium price.

Price Floor
The minimum price sellers are allowed to charge.
Binding price floors go ABOVE the market equilibrium price.

HELPFUL HINT: Think the opposite of a real room,

“ceilings on the bottom, floors on top.”

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Chapter 6 (3 of 3)
Define, illustrate, and 1. How Taxes and Subsidies Change
analyze quantity Market Outcomes
regulations
2. Price Regulations
3. Quantity Regulations

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 Key Definition (5 of 5) Diving into the Definition
Quantity regulation: A minimum or
maximum quantity that can be sold. Quota Example: Many states that have
legalized marijuana limit the amount that
Mandate: A requirement to buy or sell a people can buy per day.
minimum amount of a good.
Example: A health insurance mandate Quota Example: New York City has a taxi
requires consumers to purchase health quota. You can only drive a taxi if you have a
insurance. “medallion” of which there are only 13,600.
Example: A housing mandate requires This means there will never be more than
developers to build (hence, supply) a 13,600 taxis in NYC.
certain amount of low-income housing.
Quota Example: From 1980 to 2015 China
Quota: A limit on the maximum quantity of
implemented a one-child policy, which
a good that can be bought or sold.
limited families to a single child.
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 Binding mandate
Binding Mandates and Quotas Price

Supply
Binding quantity regulations only impact market
outcomes when they are binding.
$5 Market equilibrium
Binding mandate: The mandate needs to be
placed at a quantity that is greater than the Demand
equilibrium quantity.
50 60 Quantity
It increases the quantity bought or sold to
Price
the mandated amount. Binding quota
Supply
Binding quota: The quota needs to be set at a
quantity that is less than the equilibrium
$5 Market equilibrium
quantity.
It decreases the quantity bought or sold to Demand
the amount specified by the quota.
40 50 Quantity
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 Quotas: Zoning laws and the Seattle housing market
Zoning laws specify the type and quantity of Price Maximum
housing that can be built in a given area in the ($1,000s
quantity
city. per house)

Quota on Sellers: Current zoning laws allow for Supply

a maximum of 300,000 houses to be built in $600
Seattle.
Suppliers are willing to sell this quantity if $400 Equilibrium without quota
the price is at least $200,000.
$200
Buyers are willing to pay up to $600,000 for
these houses. Demand

Competition among the buyers pushes the 300 700 Quantity

price up to $600,000. (thousands of houses)
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 Compare Price and Quantity Regulations
First, figure out if the regulation is binding or not:
Not binding 🡪 no effect on market outcomes.
Binding 🡪 determine the new price and quantity.
Price Regulations:
New price is the regulated price.
Find the quantity that corresponds to that price.
Minimum between quantity supplied and quantity demanded.
Quantity Regulations:
New quantity is the regulated quantity.
Find the price that corresponds to that price.
Quota on sellers: Price is determined by what buyers are willing to pay for the limited quantity available.
Quota on buyers: Price at which suppliers are willing to supply the restricted quantity that buyers demand.

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 Key take-aways: Quantity regulations
Mandate
The minimum quantity that must be bought or sold.
Increases the quantity bought or sold.
Binding mandates are placed at a quantity greater than the equilibrium
quantity.
Quota
The maximum quantity that can be bought or sold.
Decreases the quantity bought or sold.
Binding quotas are placed at a quantity less than the equilibrium
quantity.

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