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400 CHAPTER 10 COMPETITIVE MARKETS: APPLICATIONS

LEARNING-BY-DOING EXERCISE 10.2
S
E D
Impact of a Subsidy
As in Learning-By-Doing Exercise 10.1, (a) There is a subsidy wedge of $3 that makes the
the demand and supply curves are after-subsidy price received by sellers $3 more than
s
d
the market price received by buyers: P P 3, or
d
d
Q 10 0.5P d s
equivalently, P P 3.
s
s
2 P , when P 2
s
s
d
Q e s (b) Also, the market clears, so that Q Q , or 10
0, when P 6 2 d s
0.5P 2 P .
d
where Q is the quantity demanded when the price Thus, 10 0.5(P 3) 2 P , so producers
s
s
s
d
s
consumers pay is P , and Q is the quantity supplied receive a price of P $9. The equilibrium price con-
s
when the price producers receive is P . sumers pay is P P $3 $6 per unit. The equilib-
d
s
d
rium quantity can be found by substituting P $6 into
Problem d d
the demand equation: Q 10 0.5P 10 0.5(6)
7 million units. (Alternatively, we could have substituted
Suppose the government provides a subsidy of $3 per s
P $9 into the supply equation.)
unit. Find the equilibrium quantity, the price buyers pay,
and the price sellers receive.
Similar Problems: 10.17, 10.18
Solution
With a $3 subsidy, two conditions must be satisfied in
equilibrium:
10.2 Sometimes a government may impose a price ceiling in a market, such as a maximum
PRICE allowable price for food or gasoline. Rent controls provide another common example
of a price ceiling because they specify maximum prices that landlords may charge ten-
CEILINGS ants. Price ceilings will affect the distribution of income and economic efficiency
AND FLOORS when they hold the price for a good or service below the level that would be observed
in equilibrium without the ceiling.
In other cases policy makers may impose a floor on the price allowed in a market.
For example, many governments have enacted laws that specify a minimum wage that
must be paid to workers. Legislative bodies often set other kinds of price floors, such
as usury laws (laws that set a minimum interest rate that can be charged for loans).
Price floors are designed to hold the price for a good or service above the level that
would be observed in equilibrium without the floor.
In contrast to the outcomes we observed with excise taxes and subsidies, markets
do not clear with price ceilings and floors. This means that we will need to think care-
fully about the way the goods or services are allocated as we analyze the effects of price
ceilings and floors on the distribution of income and economic efficiency.
PRICE CEILINGS
If the price ceiling is below the equilibrium price in a market with an upward-sloping
supply curve and a downward-sloping demand curve, the ceiling will have the follow-
ing effects:
• The market will not clear. There will be an excess demand for the good.
• The market will underproduce relative to the efficient level (i.e., the amount
that would be supplied in an unregulated market).