Chapter Six: Supply, Demand and Government Policies

(Level of Difficulty 1 ½) 

Certain government policies help underline the basis of certain goods. The total price of a good is split between two categories, either a price ceiling or a price floor. Price ceiling referring to the ‘legal’ maximum of a good or service, where there will be a need for sellers to ration the good amongst the buyers if the price ceiling is below the equilibrium price. On the other hand there is a price floor, which is the ‘legal’ minimum on the price of a good or service so if the price floor is above the equilibrium standard then there is a larger quantity supplied than the quantity demanded, where buyers’ demand will have to be rationed among sellers. Price ceiling and price floor can both be thought about to be extremes on the graphs, in other words a minimum and a maximum that are laid on by legal restrictions. Taxation on a good by the government causes the equilibrium quantity of the good falls making the size of the market for that good smaller than what it originally was. Tax imposes a conflict for both buyers and sellers, where there is a wedge between the price paid by buyers and the price received by sellers, the new equilibrium causes the buyers to pay more for the good and the sellers would receive less for it. Whether the good receives a tax or not depends on the elasticities of supply and demand, where the tax would be placed on the part that is less elastic because the quantity bought or sold can respond less easily.