6.6 The Effects of Government Intervention in Different Market Structures

Price ceilings and floors

A price ceiling set below equilibrium causes a shortage; a price floor set above equilibrium causes a surplus. In competitive markets, these controls create deadweight loss because quantity traded moves away from the efficient level. Examples: rent control (ceiling), minimum wage (floor).

Taxes and subsidies

A tax raises the price buyers pay and lowers the price sellers receive, shrinking quantity traded and creating deadweight loss; the incidence (who bears the burden) depends on relative elasticities of supply and demand — the less elastic side pays more. A subsidy works in reverse, increasing quantity traded past the efficient level and also creating deadweight loss (overproduction).

Government intervention & monopoly

For a monopoly, output is below the efficient level and price is above marginal cost, creating deadweight loss. Government can intervene using price regulation (setting P = MC for efficiency, or P = ATC for a 'fair-return' price) to increase output and lower price, reducing the monopolist's deadweight loss compared to the unregulated outcome.

Key terms

Price ceiling

A legal maximum price set below equilibrium; causes a shortage and deadweight loss.

Price floor

A legal minimum price set above equilibrium; causes a surplus and deadweight loss.

Tax incidence

How the burden of a tax is divided between buyers and sellers, depending on relative elasticities of supply and demand.

Fair-return price (P = ATC)

Regulated monopoly price set where price equals average total cost, yielding zero economic profit while covering costs.

Socially optimal price (P = MC)

Regulated monopoly price set equal to marginal cost, achieving allocative efficiency by eliminating deadweight loss.

Try an AP-style question

Antitrust laws aim to…

1. ban all mergers
2. raise all prices
3. promote competition
4. protect monopolies