Which of the following conditions must be met for a price ceiling to be considered 'binding' in a competitive market?
Consider whether a legal maximum price would affect behavior if it were higher than what people are already paying.
A price ceiling is a legal maximum; if it is lower than the price the market would naturally reach, it prevents the market from reaching equilibrium, thus becoming a binding constraint.
If the ceiling is above equilibrium, the market can still reach its natural balance, making the regulation irrelevant or non-binding.
When the ceiling equals the equilibrium price, market forces are already in balance at that level, so the law does not change the outcome.
Excess supply, or a surplus, is the result of a price floor set above equilibrium, not a price ceiling.
Question 2/ 20
What is the primary difference between a price ceiling and a price floor?
Think about the architectural metaphors of a 'ceiling' and a 'floor' in terms of vertical limits.
The terms refer to the 'ceiling' being the highest allowed price and the 'floor' being the lowest allowed price.
This reverses the actual effects; binding ceilings cause shortages because demand exceeds supply, while binding floors cause surpluses.
Usually, ceilings are intended to help buyers by keeping prices low, and floors are intended to help sellers by keeping prices high.
Both binding ceilings and binding floors reduce the quantity of goods successfully traded in the market compared to equilibrium.
Question 3/ 20
In economic terms, the study of 'tax incidence' focuses on which of the following?
Focus on the 'who' rather than the 'how much' or the 'how' of tax policy.
Tax incidence identifies who actually ends up paying the tax, regardless of who is legally required to send the check to the government.
While related, total revenue is a measure of the size of the tax times the quantity sold, not the distribution of the burden.
Administrative costs are part of the efficiency of the tax system but do not describe the sharing of the burden between buyers and sellers.
This describes a specific market reaction but does not encompass the broader concept of burden distribution across both sides of the market.
Question 4/ 20
When a binding price floor is imposed on a market, why does a surplus occur?
Recall the law of demand and law of supply when prices are kept artificially high.
A price floor prevents the price from falling to equilibrium; at the higher floor price, sellers want to sell more than buyers want to purchase.
A price floor is a movement along the curves due to a change in price, not a factor that causes the demand curve itself to shift.
A price floor changes the price and quantity supplied along the existing curve; it does not change the underlying desire to sell at all prices.
According to the law of demand, buyers purchase fewer units when the price is higher than equilibrium.
Question 5/ 20
Which side of the market generally bears more of the tax burden?
Think about which group has fewer 'choices' or alternatives when price conditions become unfavorable.
Elasticity represents the ability to leave the market; the side with fewer alternatives (less elastic) cannot respond as easily and thus bears more burden.
A more elastic side can easily switch to substitutes or exit the market, thereby avoiding the tax burden.
One of the key lessons in tax incidence is that the legal obligation does not determine the true economic burden.
The number of participants does not determine tax incidence; it is the responsiveness of those participants to price changes that matters.
Question 6/ 20
According to Figure 6-2 in the worksheet, if a price ceiling is set at 3 while the equilibrium price is 4, what is the result?
Compare the quantity demanded and quantity supplied specifically at the $3 horizontal line.
At a price of $3, quantity demanded is 180 and quantity supplied is 90, resulting in a shortage of 180 - 90 = 90 units.
A price ceiling below equilibrium causes a shortage, not a surplus, because demand exceeds supply.
This may result from a miscalculation or misreading the points on the graph for quantity supplied and demanded.
The market cannot reach equilibrium because the legal ceiling is lower than the price required to balance supply and demand.
Question 7/ 20
Looking at Figure 6-11, if a tax of 2 per unit is imposed, and the initial equilibrium is at (5, 100), what identifies the new quantity?
Consider the 'wedge' concept that represents the tax difference between buyer price and seller price.
A tax creates a wedge between what buyers pay and sellers receive; the new equilibrium quantity is where this wedge matches the size of the tax.
A tax on sellers shifts the supply curve upward, while a tax on buyers shifts the demand curve downward.
The price buyers pay will increase, but it only increases by the full amount of the tax if supply is perfectly elastic, which is not shown here.
Taxes discourage market activity, so the equilibrium quantity will necessarily fall below the pre-tax level of 100.
Question 8/ 20
In a supply and demand diagram, how is the 'tax wedge' visually represented?
Think about the vertical distance that separates the price consumers pay and the price producers pocket.
The wedge represents the difference between the price paid by buyers (Pb) and the price received by sellers (Ps), which equals the tax (T).
The horizontal distance represents the change in quantity, not the price difference created by the tax.
The area of a rectangle (T x Q) represents tax revenue, not the tax wedge itself, which is a price difference.
A tax on buyers shifts the demand curve to the left, and a tax on sellers shifts the supply curve to the left/upward.
Question 9/ 20
If a supply curve is very steep (inelastic) and a demand curve is very flat (elastic), a diagram would show that:
Focus on which curve's price point moves further away from the original equilibrium.
When supply is inelastic, sellers are less responsive to price changes and 'stick' to the market, absorbing more of the tax wedge.
Buyers bear the burden when the demand curve is steeper (more inelastic) than the supply curve.
Even with a constant tax size, the division of the burden depends on the relative slopes (elasticities) of the two curves.
A tax always reduces the equilibrium quantity unless supply or demand is perfectly inelastic.
Question 10/ 20
In Figure 4 of Chapter 6 (Mankiw), panel (b) shows a binding price floor. What represents the quantity of goods actually sold in this market?
In any trade, you need both a willing buyer and a willing seller; consider who is the limiting factor here.
Even though sellers want to provide 120 cones, they can only sell what buyers are willing to purchase at that price.
Sellers cannot force buyers to purchase more than they want; the excess supply becomes a surplus.
Markets are limited by the 'short side'; in a surplus, the amount sold is determined by the lower quantity demanded.
The price floor prevents the market from reaching the equilibrium price and quantity.
Question 11/ 20
Consider a market where demand is Qd = 20 - P and supply is Qs = 2P - 4. What is the equilibrium price and quantity?
Set the demand equation equal to the supply equation and solve for the unknown variable P first.
Setting Qd = Qs gives 20 - P = 2P - 4, so 24 = 3P, P = 8. Substituting back, Q = 20 - 8 = 12.
This likely results from a computational error in solving for P or confusing price and quantity.
At P=4, Qd = 16 but Qs = 4, so the market is not in equilibrium.
At P=10, Qd = 10 but Qs = 16, representing a surplus rather than equilibrium.
Question 12/ 20
For the market described by Qd = 20 - P and Qs = 2P - 4, for what range of prices will a price floor be binding?
Recall that a 'floor' only stops you from falling; find the equilibrium price first.
A price floor is binding only if it is set above the equilibrium price, which we calculated as $8.
A floor below equilibrium is not binding because the market will naturally settle at the higher equilibrium price.
While prices above 12 are binding, this range is incomplete as it misses prices between 8 and 12.
Prices below 4 would be binding price ceilings, not price floors, and only if the ceiling was the legal limit.
Question 13/ 20
If the government sets a price floor at $10 in the market where Qd = 20 - P and Qs = 2P - 4, what is the resulting surplus?
Calculate the quantity supplied and the quantity demanded at the floor price, then find the difference.
At P=10, Qd = 20-10=10 and Qs = 2(10)-4=16. Surplus is Qs - Qd = 16 - 10 = 6.
This is the quantity demanded at $10, not the difference between supply and demand.
This may result from subtracting the equilibrium quantity (12) from the new quantity supplied (16).
This is the quantity supplied at $10, but it doesn't account for how much buyers are actually willing to take.
Question 14/ 20
The market supply for watches is P = 100 + (10/3)Q. If an excise tax of $50 per watch is imposed on producers, what is the new supply equation?
Consider how a per-unit tax affects the cost of production for every unit supplied.
A tax on producers increases their costs, shifting the supply curve upward by the amount of the tax ($50).
This would represent a subsidy, which reduces costs for producers, rather than a tax.
The tax is a per-unit constant added to the price, not a variable that depends on the total quantity squared.
The slope of the supply curve (marginal cost) remains unchanged by a constant per-unit tax; only the intercept shifts.
Question 15/ 20
Given market demand P = 500 - 10Q and the new supply P = 150 + (10/3)Q (after a $50 tax), what is the new equilibrium quantity sold?
Set the demand equation equal to the new supply equation and solve for the variable Q.
Set 500 - 10Q = 150 + (10/3)Q. Then 350 = (40/3)Q, so Q = 350 x (3/40) = 105/4 = 26.25.
This was the original equilibrium quantity before the tax was imposed.
Quantity should decrease when a tax is imposed, not increase from the original 30 units.
This might result from a calculation error in handling the fraction 10/3 or the subtraction of terms.
Question 16/ 20
Why do economists often argue that rent control is more damaging to the housing market in the long run than in the short run?
Think about how the behavior of landlords and tenants changes as they have more time to adjust to price limits.
In the long run, landlords can stop building or maintaining apartments, and more people move to the city, making both supply and demand more responsive to price.
Elasticity typically increases over time as people find more alternatives, which exacerbates rather than solves the shortage.
Rent control is a price regulation, not a subsidy system; it usually reduces landlord income without compensation.
The law of demand is a fundamental principle that applies regardless of the time horizon.
Question 17/ 20
In the 1990s, the U.S. luxury tax on expensive yachts was repealed largely because:
Consider who has more flexibility: a person buying a luxury item or the person whose livelihood depends on making it.
Because wealthy buyers could easily buy other luxuries, they left the market, leaving the 'trapped' boat builders (inelastic supply) to pay most of the tax.
The tax actually caused significant economic hardship in the yacht-building industry, which was the primary reason for its repeal.
Yacht builders have specialized equipment and skills, making their supply relatively inelastic in the short-to-medium run.
The argument for repeal was actually about the unintended burden on the middle-class workers who built the boats.
Question 18/ 20
What is a common unintended consequence of an increase in the minimum wage, viewed as a price floor?
Think about what happens to 'excess supply' when it refers to people looking for jobs.
If the minimum wage is binding, the quantity of labor supplied by workers exceeds the quantity demanded by firms, creating a surplus of labor (unemployment).
Shortages occur when price is below equilibrium; a higher minimum wage increases the number of people wanting to work while decreasing jobs.
Higher wages act as an incentive for more people to enter the workforce (increase in quantity supplied).
Price changes cause movements along the demand curve; they do not shift the demand curve itself unless productivity changes.
Question 19/ 20
Regarding the FICA (payroll) tax, Mankiw explains that the legislated 50/50 split between firms and workers:
Recall the concept that the 'flypaper theory' of taxation is usually incorrect.
The actual incidence depends on the elasticities of labor supply and demand, regardless of whom the government officially taxes.
Efficiency and equity are separate from the statutory incidence; the market forces decide the outcome.
Markets respond to total costs; they do not 'know' or 'care' about the legal split dictated by Congress.
Firms can pass on costs depending on the elasticity of the products they sell; payroll tax is just another cost of production.
Question 20/ 20
In the 1970s, long lines at gas stations in the U.S. were primarily caused by:
Consider how supply shifts interacted with legal price limits during the oil crisis.
When supply fell, the equilibrium price rose above the legal ceiling; at that regulated price, there was a massive shortage (excess demand).
While demand for gas is generally high, the crisis was driven by a supply shock from OPEC, not a sudden surge in consumer desire.
The lines were a market-developed rationing mechanism in response to the shortage caused by the price ceiling, not a direct government order.
Producers want higher prices; the lines were caused by a price that was kept artificially low for consumers.