Chapter 6: Supply, Demand, and Government Policies

Running Example

The Apartment Rental Market

We'll use the market for apartment rentals throughout this chapter. Renters have a downward-sloping demand (fewer apartments rented as rent rises), and landlords have an upward-sloping supply (more apartments available as rent rises).

Demand: P = 1200 − 100Q rent in $/month, Q in thousands

Supply: P = 200 + 100Q landlords' minimum acceptable rent

Equilibrium: Q* = 5, P* = $700/mo where both lines cross

Without any government intervention, 5,000 apartments are rented at $700/month. CS = ½×5×500 = $1,250 (thousands), PS = ½×5×500 = $1,250 (thousands). Total surplus = $2,500.

Section 1

Price Ceilings

A price ceiling is a legal maximum price. If the government says landlords can't charge more than $500/month, that's a price ceiling. A ceiling only matters if it's set below the equilibrium price — otherwise the market would naturally settle below it anyway, and the ceiling is not binding.

When a ceiling is binding, the price is forced below equilibrium. At that low price, quantity demanded exceeds quantity supplied, creating a shortage. Some renters who want apartments can't find them.

Ceiling price: $500

Price Ceiling

Ceiling price $500

Binding? Yes

Q_d 7.00

Q_s 3.00

Shortage 4.00

CS $1,650

PS $450

DWL $400

Section 2

Price Floors

A price floor is a legal minimum price. If the government says landlords must charge at least $900/month, that's a price floor. A floor only matters if it's set above the equilibrium price — otherwise the market naturally settles above it, and the floor is not binding.

When a floor is binding, the price is forced above equilibrium. At that high price, quantity supplied exceeds quantity demanded, creating a surplus. Some landlords who want to rent apartments can't find tenants.

Floor price: $900

Price Floor

Floor price $900

Binding? Yes

Q_d 3.00

Q_s 7.00

Surplus 4.00

CS $450

PS $1,650

DWL $400

Minimum wage context: If the minimum wage is set above the equilibrium wage, it creates unemployment (a surplus of labor). Workers who keep their jobs earn more, but some workers lose their jobs entirely. The floor helps some at the expense of others.

Section 3

Who Really Pays the Tax?

When the government places a tax on a good, the key question is: who actually bears the burden? The answer depends on elasticities, not on who legally writes the check. A tax "on sellers" is partly passed on to buyers through a higher price, and a tax "on buyers" pushes the effective price sellers receive down.

The side of the market that is more inelastic (less responsive to price) bears more of the tax burden. Toggle between elastic and inelastic demand to see this in action.

Tax per unit: $200

Tax Incidence

Tax (T) $200

P_b (buyer pays) $800

Pₛ (seller gets) $600

Buyer burden $100 (50%)

Seller burden $100 (50%)

Q traded 4.00

Tax Revenue $800

Toggle demand elasticity to see how the burden shifts.

Summary

Key Takeaways

Price ceilings below equilibrium create shortages; above equilibrium they're non-binding and have no effect on the market.
Price floors above equilibrium create surpluses; below equilibrium they're non-binding and have no effect on the market.
Rent control (a price ceiling) leads to housing shortages, long waitlists, and deteriorating quality as landlords lose incentive to maintain properties.
Minimum wage (a price floor) can create unemployment when set above the market wage — workers who keep jobs earn more, but some lose jobs entirely.
Tax incidence: the more inelastic side of the market bears more of the tax burden, regardless of who legally pays the tax.
It doesn't matter whether the tax is legally placed "on" buyers or sellers — the economic incidence (who actually bears the cost) is the same.