Government Policy and Taxes

• Module 13: Price Controls (Ceilings and Floors)
• Module 14: Quantity Controls (Quotas)
• Module 15: Taxes

BIG CITY, NOT-SO-BRIGHT IDEAS

New York City is a place where you can find almost anything—that is, almost anything, except a taxicab when you need one or a decent apartment at a rent you can afford. You might think that New York’s notorious shortages of cabs and apartments are the inevitable price of big-city living. However, they are largely the product of government policies—specifically, of government policies that have, in one way or another, tried to prevail over the market forces of supply and demand.

In Section 2, we learned the principle that a market moves to equilibrium—that the market price rises or falls to the level at which the quantity of a good that people are willing to supply is equal to the quantity that other people demand.

But sometimes governments try to defy that principle. Whenever a government tries to dictate either a market price or a market quantity that’s different from the equilibrium price or quantity, the market strikes back in predictable ways.

The shortages of apartments and taxicabs in New York are two examples of what happens when the logic of the market is defied. New York’s housing shortage is the result of rent control, a law that prevents landlords from raising rents except when specifically given permission. Rent control was introduced during World War II to protect the interests of tenants, and it still remains in force. Many other American cities have had rent control at one time or another, but with the notable exceptions of New York and San Francisco, these controls have largely been done away with.

Similarly, New York’s limited supply of taxis is the result of a licensing system introduced in the 1930s. New York taxi licenses are known as “medallions,” and only taxis with medallions are allowed to pick up passengers. Although this system was originally intended to protect the interests of both drivers and customers, it has generated a shortage of taxis in the city.

In this section, we begin by examining what happens when governments try to control prices in a competitive market, keeping the price in a market either below its equilibrium level—a price ceiling such as rent control—or above it—a price floor such as the minimum wage paid to workers in many countries. We then turn to schemes such as taxi medallions that attempt to dictate the quantity of a good bought and sold. We conclude with a discussion of what happens when governments tax goods and services.