2.8 The Effects of Government Intervention in Markets

A price ceiling is a legal maximum price; it binds only when set BELOW equilibrium, creating a persistent shortage (rent control is the classic case). A price floor is a legal minimum; it binds only when set ABOVE equilibrium, creating a persistent surplus (the minimum wage creating unemployment). Non-binding controls, placed on the other side of equilibrium, change nothing.

A per-unit (excise) tax shifts the supply curve up by exactly the tax, raising the price buyers pay, lowering the price sellers keep, and shrinking quantity. Tax incidence — who really bears the burden — depends on elasticity, not on who legally pays: the more inelastic side of the market bears more of the tax. A subsidy works in reverse, shifting supply right and expanding quantity beyond equilibrium.

Both price controls and taxes prevent some mutually beneficial trades from happening, destroying total surplus. That lost surplus is deadweight loss — the triangle between the demand and supply curves over the units no longer traded. Government revenue from a tax is the tax per unit times the after-tax quantity, never the original quantity.