CHAPTER 6 – SUPPLY, DEMAND, AND GOVERNMENT POLICIES

🔹 6.1 Introduction
• Markets normally reach equilibrium on their own, where demand = supply.
• However, government sometimes intervenes through policies to control prices or
regulate market outcomes.
• The chapter explains how price controls and taxes affect markets.

🔹 6.2 Controls on Prices

Governments impose price controls when they believe the market price is unfair or wants
to help specific groups.
There are two main types:
1. Price Ceilings (maximum price)
2. Price Floors (minimum price)

🔵 A. Price Ceiling (Maximum Price)

A legally imposed maximum price that sellers can charge.
Examples:
• Rent control on apartments
• Price caps on essential medicines
When is it binding / non-binding?
1. Non-binding Price Ceiling
• Set above equilibrium price.
• Has no effect on market outcome.
• Market behaves normally.
• Illustrated in the chapter’s graph showing ceiling above equilibrium price.
2. Binding Price Ceiling
• Set below equilibrium price.
• Results in a shortage because Qd > Qs.
• Creates problems:
o Long queues
o Black markets
o Quality deterioration
• Shown in the textbook diagram where price < equilibrium leading to shortage.
🔵 B. Price Floor (Minimum Price)
A legally set minimum price buyers must pay.
Examples:
• Minimum wage laws
• Minimum support prices (MSP) for farmers
When is it binding / non-binding?
1. Non-binding Price Floor
• Set below equilibrium price.
• No effect on market.
2. Binding Price Floor
• Set above equilibrium price.
• Creates surplus because Qs > Qd.
• For minimum wage:
o Labour supply exceeds labour demand → unemployment.
• The chapter explains this using labor-market diagrams.

🔹 6.3 Taxes and Their Effects

A tax is imposed on either buyers or sellers to raise revenue or alter behavior.
But tax incidence (actual burden) depends on elasticities, not whom the tax is levied on.
Two types discussed:
• Taxes on Buyers
• Taxes on Sellers
🟣 A. Tax on Buyers
• A tax shifts the demand curve downward by the amount of the tax.
• Buyers effectively have to pay more, so they demand less.
• Result:
o Equilibrium quantity falls
o Price received by sellers falls
o Price paid by buyers rises
• The chapter shows this using a standard tax wedge diagram.
🟣 B. Tax on Sellers
• A tax shifts the supply curve upward by the tax amount.
• Sellers face higher production costs.
• Result:
o Equilibrium quantity falls
 o Price paid by buyers increases
o Price received by sellers decreases
• Again, a wedge is created between the buyer’s price and seller’s price.
🟠 C. Tax Incidence (Who bears the burden?)
The chapter emphasizes:
1. Taxes distort market outcomes
• Reduce quantity exchanged
• Raise buyer price
• Lower seller revenue
2. Tax burden depends on elasticity
• More elastic side escapes tax
• Less elastic side bears more burden
For example:
• If demand is inelastic (like petrol), buyers bear most of the tax.
• If supply is inelastic (like land), sellers bear most of the tax.
This is clearly depicted in the tax incidence graphs.
🔹 6.4 Case Study: Effects of Minimum Wage
• Minimum wage is a price floor in the labor market.
• If set above equilibrium:
o Creates unemployment (excess supply of labor).
• Young, low-skilled workers are affected the most.

🔹 6.5 Case Study: Rent Control

• Rent control is a price ceiling intended to make housing affordable.
• Long-run impact:
o Shortages
o Reduced quality
o Incentive for landlords to convert rental units to other uses
o Misallocation of housing
• The chapter labels rent control as one of the most inefficient price policies.

🔹 6.6 Taxes in the Real World

The textbook examples cover:
• Fuel taxes
• Cigarette taxes
• Taxes on labor income
 • How taxes influence supply and demand behavior

QUESTION BANK

🟦 A. SHORT ANSWER QUESTIONS (2–3 marks)

1. What is a price ceiling?
A price ceiling is a legally set maximum price that sellers are allowed to charge for a good
or service.
If it is set below equilibrium price, it becomes binding and creates a shortage because
quantity demanded exceeds quantity supplied.
Example: rent control on apartments.

2. What is a price floor?

A price floor is a legally imposed minimum price that buyers must pay for a good or
service.
If it is set above equilibrium price, it is binding and causes a surplus, because supply
exceeds demand.
Example: minimum wage laws.

3. Define tax incidence.

Tax incidence refers to how the burden of a tax is shared between buyers and sellers.
It depends not on whom the tax is imposed on, but on the elasticities of supply and
demand.
The side of the market that is less elastic bears a larger tax burden.

4. What happens when a binding price ceiling is imposed?

A binding ceiling is set below equilibrium, causing:
• Shortage
• Long queues
• Black markets
• Reduced quality or availability of goods.

5. How does a tax on sellers affect supply?

A tax on sellers increases production cost → supply curve shifts upward/leftward by the
amount of tax.
This reduces the equilibrium quantity and raises the price buyers pay.
🟩 B. MEDIUM ANSWER QUESTIONS (5–7 marks)
6. Explain binding and non-binding price ceilings with examples.
A price ceiling sets a legal maximum price.
Non-binding ceiling
• Set above equilibrium
• Has no effect on the market
Example: ceiling price ₹100 while equilibrium is ₹80.
Binding ceiling
• Set below equilibrium
• Creates a shortage because Qd > Qs
Consequences:
• Long waiting lines
• Black markets
• Poor quality goods
• Misallocation of resources
Example: Rent control, where low rent causes excess demand for apartments.

7. What are the effects of a binding price floor? Explain using minimum
wage.
A price floor sets a legal minimum price.
Binding price floor
• Set above equilibrium
• Creates surplus
In the labor market (minimum wage):
• Minimum wage > equilibrium wage
• Surplus of labor = unemployment
• Low-skilled workers are affected the most
• Firms hire fewer workers due to higher wage costs
• Teenagers and freshers face the highest unemployment
Thus, minimum wage benefits some workers but harms many others.

8. Explain how taxes on buyers affect demand and equilibrium.

A tax on buyers increases the price they pay.
• Demand curve shifts downward by the amount of the tax.
• Buyers are willing to purchase less at every price.
Results:
• Equilibrium price received by sellers falls
• Price paid by buyers rises
• Equilibrium quantity falls
This creates a tax wedge between buyer’s price and seller’s price.

9. Explain the concept of tax incidence using elasticities.

Tax incidence shows who bears the tax burden.
• The side of the market that is less elastic bears more burden.
• If demand is inelastic (e.g., petrol), buyers bear most of the tax.
• If supply is inelastic (e.g., land), sellers bear most of the tax.
• Elastic side can escape tax more easily by reducing quantity or finding alternatives.
Thus, tax incidence depends on market flexibility, not on who physically pays the tax.

10. Why do price controls often create inefficiency?

Price controls distort the natural working of supply and demand.
Inefficiencies caused:
• Shortages (when ceilings are binding)
• Surpluses (when floors are binding)
• Misallocation of resources
• Black markets
• Lower quality goods
• Discouragement of production
Markets no longer clear, reducing overall welfare.

🟥 C. LONG ANSWER QUESTIONS (10–15 marks)

11. Explain price ceilings and price floors in detail. Discuss their effects
on market outcomes.
1. Price Ceilings (Maximum Price)
a) Non-binding ceiling
• Set above equilibrium; no effect.
b) Binding ceiling
• Set below equilibrium → causes shortage.
Effects:
• Long lines
 • Black markets
• Reduced quality
• Misallocation (people who value the good more may not get it)
Example: Rent control leading to housing shortages.

2. Price Floors (Minimum Price)

a) Non-binding floor
• Set below equilibrium; no effect.
b) Binding floor
• Set above equilibrium → causes surplus.
Effects:
• Excess supply
• Wastage of goods
• Government purchases (for farmers’ MSP)
• Unemployment (in labor market)
Example: Minimum wage causing surplus of workers.

3. Conclusion
While price controls aim to help consumers/producers, they often create unintended side
effects that reduce efficiency and worsen the problem in the long run.

12. Explain how taxes affect buyers and sellers. Discuss tax incidence
with diagrams.
Taxes can be imposed on either buyers or sellers, but the effects are similar.

1. Tax on Buyers
• Demand shifts downward by tax amount.
• Buyers pay higher price; sellers receive lower price.
• Quantity decreases.

2. Tax on Sellers
• Supply shifts upward by tax amount.
• Buyers pay more; sellers receive less.
• Quantity decreases.
Both create a tax wedge between price paid and price received.

3. Tax Incidence
• Depends on elasticities, not who pays the tax.
• Less elastic side bears more burden.
Examples:
• Petrol: demand inelastic → buyers bear more tax.
• Land/farming: supply inelastic → sellers bear more tax.

4. Effects on Market
• Lower quantity traded
• Higher buyer price
• Lower seller revenue
• Deadweight loss due to reduced efficiency

13. “Government policies often lead to unintended consequences.”

Explain using rent control and minimum wage laws.
1. Rent Control (Price Ceiling)
Intended to make apartments affordable.
But in the long run:
• Shortage of rental housing
• Poor quality maintenance
• Black markets for apartments
• Inefficient use (large apartments occupied by fewer people)

2. Minimum Wage (Price Floor)

Intended to raise income of low-wage workers.
Unintended effects:
• Unemployment among unskilled workers
• Reduction in job opportunities
• Firms replace labor with machines
• Increased informal jobs with no protections
3. Conclusion
Although government interventions have good intentions, they often disrupt market forces,
leading to inefficiency, shortages, surpluses, and welfare loss.

FULL EXAM QUESTION BANK

🔵 A. VERY SHORT ANSWER QUESTIONS (1–2 marks)
1. Define price ceiling.
2. Define price floor.
3. What is a binding price ceiling?
4. What is a non-binding price ceiling?
5. What is a binding price floor?
6. What is a non-binding price floor?
7. Define shortage.
8. Define surplus.
9. What is tax incidence?
10. What is a tax wedge?
11. State one example of a price ceiling.
12. State one example of a price floor.
13. What happens when government imposes a tax?
14. When does a price ceiling cause no effect?
15. Who bears more burden when demand is inelastic?
16. Define minimum wage.
17. What is the effect of a price floor above equilibrium?
18. What does elasticity determine in taxation?
19. Give one real-life example of a tax affecting market behavior.
20. Define government intervention in markets.

🟢 B. SHORT ANSWER QUESTIONS (3–4 marks)

21. Distinguish between price ceiling and price floor.
22. What are binding and non-binding price controls?
23. Explain the concept of shortage due to price ceiling.
24. Explain the concept of surplus due to price floor.
25. Explain rent control as a price ceiling.
26. Explain minimum wage as a price floor.
27. Explain tax on buyers using a demand shift.
28. Explain tax on sellers using a supply shift.
 29. What is meant by tax burden?
30. Why do price ceilings often create black markets?
31. State the effects of a binding price floor.
32. Why are long queues a result of price ceilings?
33. What does "tax incidence is independent of legal liability" mean?
34. Explain why the less elastic side of the market bears more tax.
35. Explain how taxes reduce market activity.
36. Give two inefficiencies created by price controls.
37. How do price controls distort equilibrium?
38. Explain the idea of deadweight loss under taxes.
39. Why do governments impose price controls?
40. Why do governments impose taxes?

🟡 C. MEDIUM ANSWER QUESTIONS (5–7 marks)

41. Explain binding price ceilings with a diagram.
42. Explain binding price floors with a diagram.
43. Explain how rent control affects the housing market.
44. Explain the effects of minimum wage on labor markets.
45. Discuss the consequences of surplus created by a price floor.
46. Explain the effects of shortage created by a price ceiling.
47. Explain the effect of taxes on buyers with diagrams.
48. Explain the effect of taxes on sellers with diagrams.
49. Explain tax incidence with the help of elasticity.
50. Explain with examples how taxes affect both buyers and sellers.
51. Discuss how taxes create deadweight loss.
52. Why do governments impose agricultural support price floors (MSP)?
53. Explain how elasticity determines who bears greater tax burden.
54. Explain why government intervention may worsen market outcomes.
55. Discuss the economic arguments for and against price controls.

🔴 D. LONG ANSWER QUESTIONS (10–15 marks)

56. Explain price ceilings and price floors in detail. Discuss their effects on market
equilibrium with diagrams.
57. Discuss in detail how taxes affect market equilibrium when imposed on buyers and
sellers.
58. Explain tax incidence using elasticity concepts. Provide diagrams for all possible
cases.
 59. “Government price controls lead to unintended consequences.” Discuss with
reference to rent control and minimum wage.
60. Explain how binding price ceilings create shortages and inefficiencies.
61. Explain how binding price floors create surpluses and distort labor markets.
62. Discuss the effects of taxation on market output, prices, and welfare.
63. Explain the concept of deadweight loss of taxation with diagrams.
64. Evaluate the economic pros and cons of minimum wage laws.
65. Using diagrams, explain how supply and demand curves shift under tax policies for
buyers and sellers.
66. Discuss the real-world relevance of government interventions such as price caps,
price supports, and indirect taxes.
67. “Both buyers and sellers share the burden of taxation.” Explain with diagrams and
elasticity.
68. Discuss the short-run and long-run impacts of price controls on markets.
69. Explain with diagrams the difference between legal incidence and economic
incidence of tax.
70. Analyse why governments still use price controls despite their inefficiencies.
71.
🟣 E. DIAGRAM-BASED QUESTIONS
71. Draw and explain a non-binding price ceiling.
72. Draw and explain a binding price ceiling.
73. Draw and explain a non-binding price floor.
74. Draw and explain a binding price floor.
75. Draw a market with price ceiling showing shortage.
76. Draw a market with price floor showing surplus.
77. Draw a minimum wage diagram with unemployment.
78. Draw tax on buyers (demand curve shift).
79. Draw tax on sellers (supply curve shift).
80. Draw tax wedge showing buyer price and seller price.
81. Draw diagram showing tax incidence when demand is inelastic.
82. Draw diagram showing tax incidence when supply is inelastic.
83. Draw diagram showing deadweight loss of tax.
84. Draw diagram showing rent control effects.
85. Draw effect of agricultural price support programs.

🟤 F. CASE STUDIES / APPLICATION-BASED QUESTIONS

86. A city imposes rent control on apartments. Explain market outcomes.
 87. Government increases minimum wage. What happens to employment?
88. A tax is imposed on petrol. Who bears more burden? (Hint: inelastic demand)
89. Government sets minimum support price for wheat. Discuss effects.
90. Government imposes subsidy on farmers. How does it affect supply?
91. A country imposes a luxury tax on foreign cars. Explain effects on market.
92. A binding price ceiling on electricity is imposed. Analyse consequences.
93. Due to inflation, government caps prices of essential food items. Explain effects.
94. A state imposes a high cigarette tax. Discuss effects on consumption.
95. Labour union demands higher minimum wage. Analyse winners and losers.

🟠 G. NUMERICAL / GRAPH-BASED QUESTIONS

96. Given equilibrium price and a price ceiling, identify if it is binding or non-binding.
97. Given demand/supply schedules, show shortage or surplus under price controls.
98. Calculate new equilibrium quantity after a tax is imposed.
99. Compute buyer price and seller price after tax introduction.
100. Given elasticity values, identify who bears more tax burden.
101. Use diagrams to determine deadweight loss from taxation.
102. Using numerical values, show how tax reduces quantity exchanged.
103. Calculate unemployment created by minimum wage using hypothetical
data.
104. Identify the size of surplus when a price floor is imposed.
105. Identify the size of shortage when a price ceiling is imposed.